Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Evoke Pharma, Inc. (NASDAQ:EVOK) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Evoke Pharma Carry?
As you can see below, at the end of March 2021, Evoke Pharma had US$5.00m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$18.2m in cash, leading to a US$13.2m net cash position.
How Healthy Is Evoke Pharma's Balance Sheet?
According to the last reported balance sheet, Evoke Pharma had liabilities of US$6.25m due within 12 months, and liabilities of US$5.24m due beyond 12 months. On the other hand, it had cash of US$18.2m and US$127.8k worth of receivables due within a year. So it can boast US$6.83m more liquid assets than total liabilities.
It's good to see that Evoke Pharma has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Evoke Pharma has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Evoke Pharma 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.
It seems likely shareholders hope that Evoke Pharma can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
So How Risky Is Evoke Pharma?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Evoke Pharma had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$8.0m and booked a US$14m accounting loss. Given it only has net cash of US$13.2m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Evoke Pharma you should be aware of, and 1 of them is a bit unpleasant.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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