Health Check: How Prudently Does Verastem (NASDAQ:VSTM) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Verastem, Inc. (NASDAQ:VSTM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Verastem

What Is Verastem's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Verastem had debt of US$24.5m, up from US$20.3m in one year. However, its balance sheet shows it holds US$94.3m in cash, so it actually has US$69.8m net cash.

How Strong Is Verastem's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Verastem had liabilities of US$20.1m due within 12 months and liabilities of US$26.4m due beyond that. On the other hand, it had cash of US$94.3m and US$331.0k worth of receivables due within a year. So it actually has US$48.1m more liquid assets than total liabilities.

This surplus suggests that Verastem is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Verastem 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 Verastem 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.

In the last year Verastem had a loss before interest and tax, and actually shrunk its revenue by 84%, to US$1.7m. To be frank that doesn't bode well.

So How Risky Is Verastem?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Verastem 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$53m and booked a US$78m accounting loss. However, it has net cash of US$69.8m, so it has a bit of time before it will need more capital. 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Verastem that you should be aware of before investing here.

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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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.