The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Innate Pharma S.A. (EPA:IPH) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Innate Pharma Carry?
You can click the graphic below for the historical numbers, but it shows that Innate Pharma had €2.32m of debt in June 2019, down from €5.23m, one year before. However, its balance sheet shows it holds €165.0m in cash, so it actually has €162.6m net cash.
How Healthy Is Innate Pharma's Balance Sheet?
The latest balance sheet data shows that Innate Pharma had liabilities of €94.5m due within a year, and liabilities of €76.7m falling due after that. Offsetting this, it had €165.0m in cash and €44.2m in receivables that were due within 12 months. So it can boast €37.9m more liquid assets than total liabilities.
This surplus suggests that Innate Pharma has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Innate Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.
Although Innate Pharma made a loss at the EBIT level, last year, it was also good to see that it generated €30m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Innate Pharma 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. Innate Pharma may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Innate Pharma recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While we empathize with investors who find debt concerning, you should keep in mind that Innate Pharma has net cash of €162.6m, as well as more liquid assets than liabilities. So we are not troubled with Innate Pharma's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Innate Pharma, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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