Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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. Importantly, Surface Oncology, Inc. (NASDAQ:SURF) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Surface Oncology’s Debt?
The image below, which you can click on for greater detail, shows that at March 2020 Surface Oncology had debt of US$5.29m, up from none in one year. However, its balance sheet shows it holds US$90.1m in cash, so it actually has US$84.8m net cash.
How Strong Is Surface Oncology’s Balance Sheet?
According to the last reported balance sheet, Surface Oncology had liabilities of US$13.4m due within 12 months, and liabilities of US$36.3m due beyond 12 months. Offsetting these obligations, it had cash of US$90.1m as well as receivables valued at US$336.0k due within 12 months. So it actually has US$40.8m more liquid assets than total liabilities.
This excess liquidity suggests that Surface Oncology is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don’t think it will have any issues with its lenders. Succinctly put, Surface Oncology boasts net cash, so it’s fair to say it does not have a heavy debt load! There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Surface Oncology’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Surface Oncology reported revenue of US$40m, which is a gain of 39%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Surface Oncology?
Statistically speaking companies that lose money are riskier than those that make money. And we do note that Surface Oncology had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of US$58.1m and booked a US$28.0m accounting loss. But at least it has US$84.8m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Surface Oncology may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 4 warning signs with Surface Oncology (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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