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. We can see that ArQule, Inc. (NASDAQ:ARQL) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is ArQule's Debt?
The chart below, which you can click on for greater detail, shows that ArQule had US$14.9m in debt in June 2019; about the same as the year before. But on the other hand it also has US$179.1m in cash, leading to a US$164.2m net cash position.
A Look At ArQule's Liabilities
According to the last reported balance sheet, ArQule had liabilities of US$14.5m due within 12 months, and liabilities of US$11.1m due beyond 12 months. Offsetting these obligations, it had cash of US$179.1m as well as receivables valued at US$1.45m due within 12 months. So it can boast US$155.0m more liquid assets than total liabilities.
It's good to see that ArQule has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, ArQule boasts net cash, so it's fair to say it does not have a heavy debt load! 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 ArQule'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, ArQule made a loss at the EBIT level, and saw its revenue drop to US$9.5m, which is a fall of 47%. To be frank that doesn't bode well.
So How Risky Is ArQule?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months ArQule lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$26m and booked a US$33m accounting loss. But the saving grace is the US$164.2m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how ArQule's profit, revenue, and operating cashflow have changed over the last few years.
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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