Is Surface Oncology (NASDAQ:SURF) Using Too Much Debt?

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 note that Surface Oncology, Inc. (NASDAQ:SURF) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Surface Oncology

What Is Surface Oncology's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Surface Oncology had debt of US$14.0m, up from US$5.29m in one year. But on the other hand it also has US$171.0m in cash, leading to a US$157.1m net cash position.

How Strong Is Surface Oncology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Surface Oncology had liabilities of US$14.9m due within 12 months and liabilities of US$40.8m due beyond that. On the other hand, it had cash of US$171.0m and US$2.57m worth of receivables due within a year. So it actually has US$117.9m more liquid assets than total liabilities.

This luscious liquidity implies that Surface Oncology's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Surface Oncology has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Surface Oncology turned things around in the last 12 months, delivering and EBIT of US$26m. 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 Surface Oncology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Surface Oncology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Surface Oncology actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Surface Oncology has net cash of US$157.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in US$27m. So is Surface Oncology's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with Surface Oncology .

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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