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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Alexion Pharmaceuticals, Inc. (NASDAQ:ALXN) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
View our latest analysis for Alexion Pharmaceuticals
What Is Alexion Pharmaceuticals’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that Alexion Pharmaceuticals had US$2.56b of debt in December 2019, down from US$2.86b, one year before. But on the other hand it also has US$2.75b in cash, leading to a US$186.4m net cash position.
A Look At Alexion Pharmaceuticals’s Liabilities
The latest balance sheet data shows that Alexion Pharmaceuticals had liabilities of US$1.19b due within a year, and liabilities of US$5.08b falling due after that. Offsetting these obligations, it had cash of US$2.75b as well as receivables valued at US$1.24b due within 12 months. So its liabilities total US$2.28b more than the combination of its cash and short-term receivables.
Of course, Alexion Pharmaceuticals has a titanic market capitalization of US$24.0b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Alexion Pharmaceuticals boasts net cash, so it’s fair to say it does not have a heavy debt load!
In addition to that, we’re happy to report that Alexion Pharmaceuticals has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Alexion Pharmaceuticals can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Alexion Pharmaceuticals 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 three years, Alexion Pharmaceuticals produced sturdy free cash flow equating to 61% 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 it is always sensible to look at a company’s total liabilities, it is very reassuring that Alexion Pharmaceuticals has US$186.4m in net cash. And we liked the look of last year’s 32% year-on-year EBIT growth. 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. Case in point: We’ve spotted 1 warning sign for Alexion Pharmaceuticals you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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