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. 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 note that Cyclopharm Limited (ASX:CYC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Cyclopharm's Debt?
You can click the graphic below for the historical numbers, but it shows that Cyclopharm had AU$30.8k of debt in June 2019, down from AU$148.3k, one year before. But on the other hand it also has AU$5.77m in cash, leading to a AU$5.73m net cash position.
A Look At Cyclopharm's Liabilities
Zooming in on the latest balance sheet data, we can see that Cyclopharm had liabilities of AU$5.69m due within 12 months and liabilities of AU$5.39m due beyond that. Offsetting this, it had AU$5.77m in cash and AU$3.42m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.89m.
Of course, Cyclopharm has a market capitalization of AU$89.6m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Cyclopharm 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 ultimately the future profitability of the business will decide if Cyclopharm 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.
Over 12 months, Cyclopharm saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.
So How Risky Is Cyclopharm?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Cyclopharm had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through AU$1.1m of cash and made a loss of AU$2.4m. But the saving grace is the AU$5.73m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Cyclopharm insider transactions.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.