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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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Reata Pharmaceuticals, Inc. (NASDAQ:RETA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Reata Pharmaceuticals’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Reata Pharmaceuticals had US$79.6m of debt, an increase on US$19.7m, over one year. But it also has US$313.1m in cash to offset that, meaning it has US$233.5m net cash.
How Healthy Is Reata Pharmaceuticals’s Balance Sheet?
According to the last reported balance sheet, Reata Pharmaceuticals had liabilities of US$61.2m due within 12 months, and liabilities of US$274.7m due beyond 12 months. Offsetting these obligations, it had cash of US$313.1m as well as receivables valued at US$30.5m due within 12 months. So it actually has US$7.61m more liquid assets than total liabilities.
This state of affairs indicates that Reata Pharmaceuticals’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it’s hard to imagine that the US$2.84b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Reata Pharmaceuticals boasts net cash, so it’s fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Reata Pharmaceuticals’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.
In the last year Reata Pharmaceuticals actually shrunk its revenue by 58%, to US$28m. To be frank that doesn’t bode well.
So How Risky Is Reata Pharmaceuticals?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Reata Pharmaceuticals had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through US$90m of cash and made a loss of US$114m. While this does make the company a bit risky, it’s important to remember it has net cash of US$313m. That means it could keep spending at its current rate for more than two years. Overall, its balance sheet doesn’t seem overly risky, at the moment, but we’re always cautious until we see the positive free cash flow. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Reata Pharmaceuticals insider transactions.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.