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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that ADC Therapeutics SA (NYSE:ADCT) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is ADC Therapeutics's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 ADC Therapeutics had US$311.7m of debt, an increase on US$36.4m, over one year. However, its balance sheet shows it holds US$530.2m in cash, so it actually has US$218.5m net cash.
How Strong Is ADC Therapeutics' Balance Sheet?
The latest balance sheet data shows that ADC Therapeutics had liabilities of US$59.3m due within a year, and liabilities of US$391.4m falling due after that. On the other hand, it had cash of US$530.2m and US$15.9m worth of receivables due within a year. So it can boast US$95.4m more liquid assets than total liabilities.
This short term liquidity is a sign that ADC Therapeutics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, ADC Therapeutics 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 ADC Therapeutics 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.
While it hasn't made a profit, at least ADC Therapeutics booked its first revenue as a publicly listed company, in the last twelve months.
So How Risky Is ADC Therapeutics?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months ADC Therapeutics lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$230m and booked a US$252m accounting loss. With only US$218.5m on the balance sheet, it would appear that its going to need to raise capital again soon. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - ADC Therapeutics has 2 warning signs we think you should be aware of.
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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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.