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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. Importantly, Innoviva, Inc. (NASDAQ:INVA) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Innoviva's Net Debt?
As you can see below, Innoviva had US$383.4m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has US$479.2m in cash to offset that, meaning it has US$95.8m net cash.
How Healthy Is Innoviva's Balance Sheet?
The latest balance sheet data shows that Innoviva had liabilities of US$3.90m due within a year, and liabilities of US$383.5m falling due after that. Offsetting these obligations, it had cash of US$479.2m as well as receivables valued at US$92.2m due within 12 months. So it actually has US$184.0m more liquid assets than total liabilities.
This short term liquidity is a sign that Innoviva could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Innoviva boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Innoviva grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Innoviva's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Innoviva 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. Over the last three years, Innoviva recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Innoviva has net cash of US$95.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$295m, being 96% of its EBIT. So is Innoviva's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Innoviva you should be aware of.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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