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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.' 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 Fulgent Genetics, Inc. (NASDAQ:FLGT) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Fulgent Genetics Carry?
As you can see below, at the end of March 2021, Fulgent Genetics had US$15.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds US$409.8m in cash, so it actually has US$394.7m net cash.
A Look At Fulgent Genetics' Liabilities
We can see from the most recent balance sheet that Fulgent Genetics had liabilities of US$196.5m falling due within a year, and liabilities of US$987.0k due beyond that. Offsetting this, it had US$409.8m in cash and US$219.1m in receivables that were due within 12 months. So it can boast US$431.4m more liquid assets than total liabilities.
This surplus suggests that Fulgent Genetics is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Fulgent Genetics has more cash than debt is arguably a good indication that it can manage its debt safely.
Although Fulgent Genetics made a loss at the EBIT level, last year, it was also good to see that it generated US$567m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Fulgent Genetics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Fulgent Genetics 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 year, Fulgent Genetics recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Fulgent Genetics has US$394.7m in net cash and a decent-looking balance sheet. So we don't think Fulgent Genetics's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Fulgent Genetics has 5 warning signs (and 2 which are significant) we think you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.
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