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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Gilead Sciences, Inc. (NASDAQ:GILD) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Gilead Sciences's Debt?
You can click the graphic below for the historical numbers, but it shows that Gilead Sciences had US$26.1b of debt in June 2019, down from US$29.1b, one year before. However, its balance sheet shows it holds US$28.4b in cash, so it actually has US$2.28b net cash.
A Look At Gilead Sciences's Liabilities
We can see from the most recent balance sheet that Gilead Sciences had liabilities of US$8.96b falling due within a year, and liabilities of US$31.5b due beyond that. On the other hand, it had cash of US$28.4b and US$3.40b worth of receivables due within a year. So its liabilities total US$8.70b more than the combination of its cash and short-term receivables.
Since publicly traded Gilead Sciences shares are worth a very impressive total of US$80.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Gilead Sciences boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Gilead Sciences has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gilead Sciences can strengthen its balance sheet over time. 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. While Gilead Sciences 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. During the last three years, Gilead Sciences generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While Gilead Sciences does have more liabilities than liquid assets, it also has net cash of US$2.3b. And it impressed us with free cash flow of US$7.4b, being 81% of its EBIT. So we don't have any problem with Gilead Sciences's use of debt. Given Gilead Sciences has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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