Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Enanta Pharmaceuticals, Inc. (NASDAQ:ENTA) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Enanta Pharmaceuticals's Debt?
You can click the graphic below for the historical numbers, but it shows that Enanta Pharmaceuticals had US$1.63m of debt in June 2019, down from US$1.84m, one year before. However, it does have US$389.2m in cash offsetting this, leading to net cash of US$387.6m.
How Strong Is Enanta Pharmaceuticals's Balance Sheet?
We can see from the most recent balance sheet that Enanta Pharmaceuticals had liabilities of US$20.5m falling due within a year, and liabilities of US$4.89m due beyond that. Offsetting these obligations, it had cash of US$389.2m as well as receivables valued at US$44.4m due within 12 months. So it can boast US$408.2m more liquid assets than total liabilities.
This surplus suggests that Enanta Pharmaceuticals is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Enanta Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Enanta Pharmaceuticals's load is not too heavy, because its EBIT was down 40% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Enanta Pharmaceuticals'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Enanta Pharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Enanta Pharmaceuticals recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Enanta Pharmaceuticals has net cash of US$388m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$85m, being 82% of its EBIT. So is Enanta Pharmaceuticals's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Enanta Pharmaceuticals's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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