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Here's Why First Solar (NASDAQ:FSLR) Can Manage Its Debt Responsibly

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.’ 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. We can see that First Solar, Inc. (NASDAQ:FSLR) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for First Solar

What Is First Solar’s Net Debt?

As you can see below, First Solar had US$260.9m of debt at September 2020, down from US$489.5m a year prior. However, it does have US$1.63b in cash offsetting this, leading to net cash of US$1.37b.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is First Solar’s Balance Sheet?

We can see from the most recent balance sheet that First Solar had liabilities of US$731.1m falling due within a year, and liabilities of US$858.0m due beyond that. Offsetting this, it had US$1.63b in cash and US$310.5m in receivables that were due within 12 months. So it actually has US$352.2m more liquid assets than total liabilities.

This short term liquidity is a sign that First Solar could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that First Solar has more cash than debt is arguably a good indication that it can manage its debt safely.

Although First Solar made a loss at the EBIT level, last year, it was also good to see that it generated US$541m 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 First Solar can strengthen its balance sheet over time. 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. First Solar 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. Looking at the most recent year, First Solar recorded free cash flow of 27% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company’s debt, in this case First Solar has US$1.37b in net cash and a decent-looking balance sheet. So we are not troubled with First Solar’s debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Take risks, for example – First Solar has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.

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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