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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.’ 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. We can see that Sutro Biopharma, Inc. (NASDAQ:STRO) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Sutro Biopharma’s Debt?
The chart below, which you can click on for greater detail, shows that Sutro Biopharma had US$14.3m in debt in March 2019; about the same as the year before. However, it does have US$170.6m in cash offsetting this, leading to net cash of US$156.3m.
How Strong Is Sutro Biopharma’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sutro Biopharma had liabilities of US$31.1m due within 12 months and liabilities of US$40.6m due beyond that. On the other hand, it had cash of US$170.6m and US$3.34m worth of receivables due within a year. So it actually has US$102.2m more liquid assets than total liabilities.
This surplus liquidity suggests that Sutro Biopharma’s balance sheet could take a hit just as well as Homer Simpson’s head can take a punch. On this view, it seems its balance sheet is as strong as a black-belt karate master. Given that Sutro Biopharma has more cash than debt, we’re pretty confident it can manage its debt safely. 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 Sutro Biopharma’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Sutro Biopharma saw its revenue drop to US$41m, which is a fall of 2.8%. That’s not what we would hope to see.
So How Risky Is Sutro Biopharma?
Although Sutro Biopharma had negative earnings before interest and tax (EBIT) over the last twelve months, it generated positive free cash flow of US$6.1m. So although it is loss-making, it doesn’t seem to have too much near-term balance sheet risk, keeping in mind the net cash. We’ll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. For riskier companies like Sutro Biopharma I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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.