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.' 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 PTC Therapeutics, Inc. (NASDAQ:PTCT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Therapeutics's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Therapeutics had debt of US$967.2m, up from US$313.1m in one year. However, its balance sheet shows it holds US$1.14b in cash, so it actually has US$173.8m net cash.
A Look At Therapeutics's Liabilities
The latest balance sheet data shows that Therapeutics had liabilities of US$253.8m due within a year, and liabilities of US$1.42b falling due after that. Offsetting these obligations, it had cash of US$1.14b as well as receivables valued at US$56.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$472.3m.
Since publicly traded Therapeutics shares are worth a total of US$4.38b, it seems unlikely that this level of liabilities would be a major threat. 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, Therapeutics 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 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.
In the last year Therapeutics wasn't profitable at an EBIT level, but managed to grow its revenue by 21%, to US$358m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Therapeutics?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year Therapeutics 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$193m and booked a US$441m accounting loss. But the saving grace is the US$173.8m on the balance sheet. That means it could keep spending at its current rate for more than two years. Therapeutics's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger 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. Be aware that Therapeutics is showing 2 warning signs in our investment analysis , you should know about...
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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