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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ironwood Pharmaceuticals, Inc. (NASDAQ:IRWD) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Ironwood Pharmaceuticals's Debt?
The chart below, which you can click on for greater detail, shows that Ironwood Pharmaceuticals had US$401.5m in debt in June 2019; about the same as the year before. However, because it has a cash reserve of US$98.9m, its net debt is less, at about US$302.6m.
A Look At Ironwood Pharmaceuticals's Liabilities
We can see from the most recent balance sheet that Ironwood Pharmaceuticals had liabilities of US$110.9m falling due within a year, and liabilities of US$424.2m due beyond that. On the other hand, it had cash of US$98.9m and US$103.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$332.4m.
Ironwood Pharmaceuticals has a market capitalization of US$1.39b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ironwood Pharmaceuticals 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.
In the last year Ironwood Pharmaceuticals managed to grow its revenue by 11%, to US$367m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Ironwood Pharmaceuticals produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$69m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$78m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. For riskier companies like Ironwood Pharmaceuticals I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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