Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Cosmo Pharmaceuticals N.V. (VTX:COPN) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Cosmo Pharmaceuticals's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Cosmo Pharmaceuticals had debt of €157.4m, up from €4.26m in one year. However, its balance sheet shows it holds €324.0m in cash, so it actually has €166.6m net cash.
How Strong Is Cosmo Pharmaceuticals's Balance Sheet?
According to the last reported balance sheet, Cosmo Pharmaceuticals had liabilities of €16.4m due within 12 months, and liabilities of €174.0m due beyond 12 months. Offsetting this, it had €324.0m in cash and €15.4m in receivables that were due within 12 months. So it actually has €149.0m more liquid assets than total liabilities.
This surplus suggests that Cosmo Pharmaceuticals is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Cosmo Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Cosmo Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Cosmo Pharmaceuticals had negative earnings before interest and tax, and actually shrunk its revenue by 29%, to €51m. That makes us nervous, to say the least.
So How Risky Is Cosmo Pharmaceuticals?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year Cosmo Pharmaceuticals had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through €34m of cash and made a loss of €31m. But the saving grace is the €166.6m on the balance sheet. That means it could keep spending at its current rate for more than two years. 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. For riskier companies like Cosmo Pharmaceuticals 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.
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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