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 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. As with many other companies Ionis Pharmaceuticals, Inc. (NASDAQ:IONS) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Ionis Pharmaceuticals Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Ionis Pharmaceuticals had debt of US$650.1m, up from US$614.4m in one year. But it also has US$2.26b in cash to offset that, meaning it has US$1.61b net cash.
A Look At Ionis Pharmaceuticals's Liabilities
The latest balance sheet data shows that Ionis Pharmaceuticals had liabilities of US$252.5m due within a year, and liabilities of US$1.20b falling due after that. Offsetting these obligations, it had cash of US$2.26b as well as receivables valued at US$10.5m due within 12 months. So it can boast US$817.9m more liquid assets than total liabilities.
This surplus suggests that Ionis Pharmaceuticals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ionis Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Ionis Pharmaceuticals grew its EBIT by 642% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Ionis Pharmaceuticals 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ionis Pharmaceuticals 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. Happily for any shareholders, Ionis Pharmaceuticals actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Ionis Pharmaceuticals has US$1.6b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 755% of that EBIT to free cash flow, bringing in US$679m. So we don't think Ionis Pharmaceuticals's use of debt is risky. We'd be very excited to see if Ionis Pharmaceuticals insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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