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 note that Alexion Pharmaceuticals, Inc. (NASDAQ:ALXN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Alexion Pharmaceuticals’s Debt?
As you can see below, Alexion Pharmaceuticals had US$2.53b of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$2.85b in cash, so it actually has US$322.3m net cash.
How Healthy Is Alexion Pharmaceuticals’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alexion Pharmaceuticals had liabilities of US$1.12b due within 12 months and liabilities of US$5.09b due beyond that. On the other hand, it had cash of US$2.85b and US$1.37b worth of receivables due within a year. So its liabilities total US$2.0b more than the combination of its cash and short-term receivables.
Since publicly traded Alexion Pharmaceuticals shares are worth a very impressive total of US$23.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Alexion Pharmaceuticals boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, Alexion Pharmaceuticals grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. 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 Alexion Pharmaceuticals 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. Alexion Pharmaceuticals 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. Over the most recent three years, Alexion Pharmaceuticals recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Alexion Pharmaceuticals has US$322.3m in net cash. And it impressed us with its EBIT growth of 36% over the last year. So is Alexion Pharmaceuticals’s debt a risk? It doesn’t seem so to us. 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 – Alexion Pharmaceuticals has 2 warning signs we think you should be aware of.
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.
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