These 4 Measures Indicate That Fabrinet (NYSE:FN) Is Using Debt Safely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. 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?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fabrinet

How Much Debt Does Fabrinet Carry?

The image below, which you can click on for greater detail, shows that Fabrinet had debt of US$19.0m at the end of December 2022, a reduction from US$33.4m over a year. But it also has US$527.6m in cash to offset that, meaning it has US$508.6m net cash.

How Healthy Is Fabrinet's Balance Sheet?

We can see from the most recent balance sheet that Fabrinet had liabilities of US$549.6m falling due within a year, and liabilities of US$34.3m due beyond that. Offsetting this, it had US$527.6m in cash and US$533.6m in receivables that were due within 12 months. So it can boast US$477.3m 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 35% over the last twelve months, and that growth will make it easier to handle its 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 Fabrinet's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Fabrinet has net cash of US$508.6m, as well as more liquid assets than liabilities. And we liked the look of last year's 35% year-on-year EBIT growth. So we don't think Fabrinet's use of debt is risky. 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 1 warning sign for Fabrinet you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.