Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Fulgent Genetics, Inc. (NASDAQ:FLGT) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Fulgent Genetics Carry?
The image below, which you can click on for greater detail, shows that at March 2021 Fulgent Genetics had debt of US$15.0m, up from none in one year. However, its balance sheet shows it holds US$409.8m in cash, so it actually has US$394.7m net cash.
How Strong Is Fulgent Genetics’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fulgent Genetics had liabilities of US$196.5m due within 12 months 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 excess liquidity suggests that Fulgent Genetics is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face 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$564m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Fulgent Genetics can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept 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. During the last year, Fulgent Genetics produced sturdy free cash flow equating to 58% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet.