David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that ObsEva SA (NASDAQ:OBSV) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is ObsEva's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 ObsEva had US$24.8m of debt, an increase on none, over one year. However, it does have US$91.0m in cash offsetting this, leading to net cash of US$66.2m.
How Healthy Is ObsEva's Balance Sheet?
According to the last reported balance sheet, ObsEva had liabilities of US$26.8m due within 12 months, and liabilities of US$30.5m due beyond 12 months. Offsetting these obligations, it had cash of US$91.0m as well as receivables valued at US$776.0k due within 12 months. So it can boast US$34.5m more liquid assets than total liabilities.
It's good to see that ObsEva 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. Simply put, the fact that ObsEva has more cash than debt is arguably a good indication that it can manage its debt safely. 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 ObsEva can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Given its lack of meaningful operating revenue, ObsEva shareholders no doubt hope it can fund itself until it has a profitable product.
So How Risky Is ObsEva?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year ObsEva had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through US$90m of cash and made a loss of US$108m. But at least it has US$66.2m on the balance sheet to spend on growth, near-term. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for ObsEva (2 make us uncomfortable!) that you should be aware of before investing here.
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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