Is Verona Pharma (NASDAQ:VRNA) A Risky Investment?

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.' 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 Verona Pharma plc (NASDAQ:VRNA) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Verona Pharma

What Is Verona Pharma's Net Debt?

As you can see below, at the end of September 2023, Verona Pharma had US$19.9m of debt, up from US$5.04m a year ago. Click the image for more detail. But on the other hand it also has US$257.4m in cash, leading to a US$237.5m net cash position.

How Healthy Is Verona Pharma's Balance Sheet?

We can see from the most recent balance sheet that Verona Pharma had liabilities of US$9.01m falling due within a year, and liabilities of US$19.9m due beyond that. On the other hand, it had cash of US$257.4m and US$9.51m worth of receivables due within a year. So it actually has US$237.9m more liquid assets than total liabilities.

This excess liquidity suggests that Verona Pharma is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Verona Pharma boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Verona 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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Verona Pharma can make progress and gain better traction for the business, before it runs low on cash.

So How Risky Is Verona Pharma?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Verona Pharma had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$48m of cash and made a loss of US$51m. But the saving grace is the US$237.5m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. We've identified 2 warning signs with Verona Pharma (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.