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Is Illumina (NASDAQ:ILMN) Using Too Much Debt?

Simply Wall St

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Illumina, Inc. (NASDAQ:ILMN) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Illumina

What Is Illumina's Net Debt?

The image below, which you can click on for greater detail, shows that Illumina had debt of US$1.15b at the end of March 2020, a reduction from US$1.74b over a year. But on the other hand it also has US$3.33b in cash, leading to a US$2.18b net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Illumina's Balance Sheet?

The latest balance sheet data shows that Illumina had liabilities of US$1.05b due within a year, and liabilities of US$1.57b falling due after that. On the other hand, it had cash of US$3.33b and US$472.0m worth of receivables due within a year. So it can boast US$1.18b more liquid assets than total liabilities.

This surplus suggests that Illumina has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Illumina has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Illumina grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Illumina'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Illumina 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. During the last three years, Illumina generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Illumina has US$2.18b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$941m, being 91% of its EBIT. So is Illumina's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Illumina, you may well want to click here to check an interactive graph of its earnings per share history.

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.

This article by Simply Wall St is general in nature. 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.

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