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. 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 Lam Research Corporation (NASDAQ:LRCX) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Lam Research's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Lam Research had debt of US$4.42b, up from US$2.38b in one year. However, its balance sheet shows it holds US$5.59b in cash, so it actually has US$1.17b net cash.
How Strong Is Lam Research's Balance Sheet?
We can see from the most recent balance sheet that Lam Research had liabilities of US$2.46b falling due within a year, and liabilities of US$4.95b due beyond that. On the other hand, it had cash of US$5.59b and US$1.64b worth of receivables due within a year. So it has liabilities totalling US$180.6m more than its cash and near-term receivables, combined.
This state of affairs indicates that Lam Research's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$37.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Lam Research boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Lam Research's load is not too heavy, because its EBIT was down 22% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Lam Research's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Lam Research 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, Lam Research generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Lam Research has US$1.17b in net cash. And it impressed us with free cash flow of US$2.6b, being 91% of its EBIT. So we are not troubled with Lam Research's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Lam Research insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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