Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Lam Research Corporation (NASDAQ:LRCX) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Lam Research's Net Debt?
As you can see below, at the end of September 2020, Lam Research had US$5.78b of debt, up from US$4.42b a year ago. Click the image for more detail. But on the other hand it also has US$6.66b in cash, leading to a US$875.1m net cash position.
How Healthy Is Lam Research's Balance Sheet?
The latest balance sheet data shows that Lam Research had liabilities of US$3.41b due within a year, and liabilities of US$6.23b falling due after that. Offsetting this, it had US$6.66b in cash and US$2.32b in receivables that were due within 12 months. So its liabilities total US$662.0m more than the combination of its cash and short-term receivables.
Having regard to Lam Research's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$68.0b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Lam Research boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Lam Research has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Lam Research's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Lam Research may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Lam Research recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Lam Research has US$875.1m in net cash. And it impressed us with free cash flow of US$2.1b, being 81% of its EBIT. So is Lam Research's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Lam Research , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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