Is Fabrinet (NYSE:FN) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Fabrinet (NYSE:FN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

You can click the graphic below for the historical numbers, but it shows that Fabrinet had US$12.2m of debt in June 2023, down from US$27.4m, one year before. But it also has US$550.7m in cash to offset that, meaning it has US$538.5m net cash.

A Look At Fabrinet's Liabilities

We can see from the most recent balance sheet that Fabrinet had liabilities of US$481.9m falling due within a year, and liabilities of US$29.1m due beyond that. On the other hand, it had cash of US$550.7m and US$531.8m worth of receivables due within a year. So it actually has US$571.5m more liquid assets than total liabilities.

This surplus suggests that Fabrinet has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Fabrinet boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Fabrinet has been able to increase its EBIT by 26% 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 ultimately the future profitability of the business will decide if Fabrinet can strengthen its balance sheet over time. 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. Fabrinet 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. Looking at the most recent three years, Fabrinet recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Fabrinet has US$538.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 26% over the last year. So is Fabrinet's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Fabrinet has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.