Does Fabrinet (NYSE:FN) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Fabrinet (NYSE:FN) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Fabrinet

What Is Fabrinet's Net Debt?

As you can see below, Fabrinet had US$27.4m of debt at June 2022, down from US$39.5m a year prior. However, it does have US$478.3m in cash offsetting this, leading to net cash of US$450.9m.

A Look At Fabrinet's Liabilities

We can see from the most recent balance sheet that Fabrinet had liabilities of US$538.5m falling due within a year, and liabilities of US$43.5m due beyond that. Offsetting this, it had US$478.3m in cash and US$452.8m in receivables that were due within 12 months. So it actually has US$349.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Fabrinet could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Fabrinet has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Fabrinet grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Fabrinet can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Fabrinet has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Fabrinet recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Fabrinet has net cash of US$450.9m, as well as more liquid assets than liabilities. And we liked the look of last year's 36% year-on-year EBIT growth. So is Fabrinet'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Fabrinet (of which 1 shouldn't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.