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.' 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 First Solar, Inc. (NASDAQ:FSLR) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does First Solar Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 First Solar had US$585.5m of debt, an increase on US$478.3m, over one year. However, it does have US$2.12b in cash offsetting this, leading to net cash of US$1.53b.
How Strong Is First Solar's Balance Sheet?
We can see from the most recent balance sheet that First Solar had liabilities of US$836.5m falling due within a year, and liabilities of US$1.29b due beyond that. On the other hand, it had cash of US$2.12b and US$708.6m worth of receivables due within a year. So it actually has US$698.0m more liquid assets than total liabilities.
This short term liquidity is a sign that First Solar could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that First Solar has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if First Solar 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.
In the last year First Solar actually shrunk its revenue by 16%, to US$2.2b. That's not what we would hope to see.
So How Risky Is First Solar?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that First Solar had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through US$1.3b of cash and made a loss of US$6.2m. But at least it has US$2.1b on the balance sheet to spend on growth, near-term. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting First Solar insider transactions.
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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