Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Castle Biosciences, Inc. (NASDAQ:CSTL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
How Much Debt Does Castle Biosciences Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Castle Biosciences had US$24.9m of debt, an increase on US$24.5, over one year. But on the other hand it also has US$94.5m in cash, leading to a US$69.6m net cash position.
A Look At Castle Biosciences's Liabilities
According to the last reported balance sheet, Castle Biosciences had liabilities of US$9.24m due within 12 months, and liabilities of US$21.6m due beyond 12 months. Offsetting these obligations, it had cash of US$94.5m as well as receivables valued at US$12.4m due within 12 months. So it can boast US$76.0m more liquid assets than total liabilities.
This surplus suggests that Castle Biosciences has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Castle Biosciences has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, Castle Biosciences made a loss at the EBIT level, last year, but improved that to positive EBIT of US$9.5m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Castle Biosciences's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Castle Biosciences may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Castle Biosciences recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
While we empathize with investors who find debt concerning, you should keep in mind that Castle Biosciences has net cash of US$69.6m, as well as more liquid assets than liabilities. So we don't have any problem with Castle Biosciences's use of debt. We'd be motivated to research the stock further if we found out that Castle Biosciences insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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.
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