We Think Fabrinet (NYSE:FN) Can Manage Its Debt With Ease

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.' 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 is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for Fabrinet

What Is Fabrinet's Net Debt?

The image below, which you can click on for greater detail, shows that Fabrinet had debt of US$15.4m at the end of March 2023, a reduction from US$30.4m over a year. However, it does have US$538.7m in cash offsetting this, leading to net cash of US$523.3m.

How Strong Is Fabrinet's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fabrinet had liabilities of US$555.0m due within 12 months and liabilities of US$32.2m due beyond that. Offsetting this, it had US$538.7m in cash and US$561.4m in receivables that were due within 12 months. So it can boast US$512.9m 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. 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 31% 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 40% 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$523.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 31% over the last year. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Fabrinet you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.