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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, La Jolla Pharmaceutical Company (NASDAQ:LJPC) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is La Jolla Pharmaceutical's Net Debt?
The chart below, which you can click on for greater detail, shows that La Jolla Pharmaceutical had US$124.4m in debt in June 2019; about the same as the year before. However, because it has a cash reserve of US$123.4m, its net debt is less, at about US$905.0k.
How Healthy Is La Jolla Pharmaceutical's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that La Jolla Pharmaceutical had liabilities of US$22.0m due within 12 months and liabilities of US$160.5m due beyond that. Offsetting these obligations, it had cash of US$123.4m as well as receivables valued at US$1.89m due within 12 months. So its liabilities total US$57.1m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because La Jolla Pharmaceutical is worth US$251.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Carrying virtually no net debt, La Jolla Pharmaceutical has a very light debt load indeed. 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 La Jolla Pharmaceutical'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.
Over 12 months, La Jolla Pharmaceutical reported revenue of US$18m, which is a gain of 639%. That's virtually the hole-in-one of revenue growth!
While we can certainly savour La Jolla Pharmaceutical's tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. Its EBIT loss was a whopping US$145m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$119m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 La Jolla Pharmaceutical insider transactions.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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