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 Heron Therapeutics, Inc. (NASDAQ:HRTX) does have debt on its balance sheet. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Heron Therapeutics Carry?
As you can see below, at the end of March 2021, Heron Therapeutics had US$7.56m of debt, up from US$5.93m a year ago. Click the image for more detail. But it also has US$166.5m in cash to offset that, meaning it has US$158.9m net cash.
A Look At Heron Therapeutics' Liabilities
Zooming in on the latest balance sheet data, we can see that Heron Therapeutics had liabilities of US$100.9m due within 12 months and liabilities of US$13.8m due beyond that. On the other hand, it had cash of US$166.5m and US$38.5m worth of receivables due within a year. So it actually has US$90.3m more liquid assets than total liabilities.
This short term liquidity is a sign that Heron Therapeutics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Heron Therapeutics 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 it is future earnings, more than anything, that will determine Heron Therapeutics'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, Heron Therapeutics made a loss at the EBIT level, and saw its revenue drop to US$83m, which is a fall of 40%. That makes us nervous, to say the least.
So How Risky Is Heron Therapeutics?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Heron Therapeutics had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through US$198m of cash and made a loss of US$228m. While this does make the company a bit risky, it's important to remember it has net cash of US$158.9m. That kitty means the company can keep spending for growth for at least two years, at current rates. 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. For example - Heron Therapeutics has 3 warning signs we think you should be aware of.
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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