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.  Importantly, Fabrinet (NYSE:FN) does carry debt.  But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow.   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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Fabrinet Carry?

The image below, which you can click on for greater detail, shows that Fabrinet had debt of US$3.04m at the end of March 2024, a reduction from US$15.4m over a year.    But on the other hand it also has US$794.0m in cash, leading to a US$791.0m net cash position.  

NYSE:FN Debt to Equity History June 4th 2024

How Healthy Is Fabrinet's Balance Sheet?

We can see from the most recent balance sheet that Fabrinet had liabilities of US$544.3m falling due within a year, and liabilities of US$32.5m due beyond that.   Offsetting these obligations, it had cash of US$794.0m as well as receivables valued at US$583.9m due within 12 months.   So it actually has US$801.1m more liquid assets than total liabilities.  

This short term liquidity is a sign that Fabrinet could probably pay off its debt with ease, as its balance sheet is far from stretched.    Succinctly put, Fabrinet boasts net cash, so it's fair to say it does not have a heavy debt load!  

The good news is that Fabrinet has increased its EBIT by 5.7% over twelve months, which should ease any concerns about debt repayment.      The balance sheet is clearly the area to focus on when you are analysing debt.  But it is future earnings, more than anything, that will determine Fabrinet'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.  

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash.   Fabrinet 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, Fabrinet produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect.  This free cash flow puts the company in a good position to pay down debt, when appropriate.  

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Fabrinet has net cash of US$791.0m, as well as more liquid assets than liabilities.     The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in US$347m.     So is Fabrinet's debt a risk? It doesn't seem so to us.    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.   To that end, you should be aware of the   1 warning sign we've spotted with Fabrinet .  

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.

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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.