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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Fabrinet (NYSE:FN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Fabrinet

How Much Debt Does Fabrinet Carry?

As you can see below, Fabrinet had US$6.08m of debt at December 2023, down from US$19.0m a year prior. But on the other hand it also has US$740.7m in cash, leading to a US$734.6m net cash position.

How Strong Is Fabrinet's Balance Sheet?

According to the last reported balance sheet, Fabrinet had liabilities of US$486.8m due within 12 months, and liabilities of US$35.0m due beyond 12 months. Offsetting this, it had US$740.7m in cash and US$584.6m in receivables that were due within 12 months. So it can boast US$803.5m 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.

And we also note warmly that Fabrinet grew its EBIT by 10% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the most recent three years, Fabrinet recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Fabrinet has US$734.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$277m, being 66% of its EBIT. So we don't think Fabrinet's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Fabrinet is showing 1 warning sign in our investment analysis , you should know about...

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.