David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Lam Research Society (NASDAQ: LRCX) has debt on its balance sheet. But should shareholders worry about its use of debt?
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Lam Research
What is Lam Research’s net debt?
The image below, which you can click on for more details, shows Lam Research had $4.96 billion in debt at the end of March 2022, down from $5.77 billion year-over-year. However, he also had $4.35 billion in cash, so his net debt is $607.3 million.
A Look at Lam Research’s Responsibilities
According to the latest published balance sheet, Lam Research had liabilities of US$4.19 billion due within 12 months and liabilities of US$6.37 billion due beyond 12 months. In compensation for these obligations, it had liquid assets of 4.35 billion US dollars as well as receivables valued at 3.70 billion US dollars due within 12 months. Thus, its liabilities total $2.51 billion more than the combination of its cash and short-term receivables.
Of course, Lam Research has a titanic market capitalization of US$73.7 billion, so those liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. Either way, Lam Research has virtually no net debt, so it’s fair to say it’s not heavily leveraged!
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Lam Research has a low net debt to EBITDA ratio of just 0.11. And its EBIT easily covers its interest costs, which is 29.4 times the size. So we’re pretty relaxed about his super-conservative use of debt. On top of that, we are happy to report that Lam Research increased its EBIT by 33%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Lam Research’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Lam Research has produced strong free cash flow equivalent to 70% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Interest coverage from Lam Research suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not stop there, since its EBIT growth rate also confirms this impression! It seems that Lam Research has no trouble standing and has no reason to fear its lenders. In our view, he has a healthy and happy record. Another factor that would give us confidence in Lam Research would be if insiders have been buying stocks: if you are also aware of this signal, you can discover it instantly by clicking on this link.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.