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. 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. As with many other companies Sutro Biopharma, Inc. (NASDAQ:STRO) 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sutro Biopharma's Debt?
You can click the graphic below for the historical numbers, but it shows that Sutro Biopharma had US$11.3m of debt in September 2019, down from US$14.7m, one year before. However, it does have US$125.2m in cash offsetting this, leading to net cash of US$113.8m.
How Strong Is Sutro Biopharma's Balance Sheet?
We can see from the most recent balance sheet that Sutro Biopharma had liabilities of US$35.9m falling due within a year, and liabilities of US$25.9m due beyond that. On the other hand, it had cash of US$125.2m and US$7.53m worth of receivables due within a year. So it can boast US$70.9m more liquid assets than total liabilities.
It's good to see that Sutro Biopharma has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sutro Biopharma boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sutro Biopharma'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.
Over 12 months, Sutro Biopharma reported revenue of US$51m, which is a gain of 116%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!
So How Risky Is Sutro Biopharma?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Sutro Biopharma had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through US$60m of cash and made a loss of US$42m. However, it has net cash of US$113.8m, so it has a bit of time before it will need more capital. Importantly, Sutro Biopharma's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sutro Biopharma is showing 3 warning signs in our investment analysis , and 2 of those can't be ignored...
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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