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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. Importantly, Innoviva, Inc. (NASDAQ:INVA) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Innoviva's Debt?
The chart below, which you can click on for greater detail, shows that Innoviva had US$379.2m in debt in March 2020; about the same as the year before. However, it does have US$384.0m in cash offsetting this, leading to net cash of US$4.80m.
A Look At Innoviva's Liabilities
The latest balance sheet data shows that Innoviva had liabilities of US$2.80m due within a year, and liabilities of US$379.3m falling due after that. Offsetting this, it had US$384.0m in cash and US$82.1m in receivables that were due within 12 months. So it actually has US$83.9m more liquid assets than total liabilities.
This surplus suggests that Innoviva has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Innoviva boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Innoviva grew its EBIT by 7.9% in the last year, making that debt load look even more manageable. 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 Innoviva 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Innoviva generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Innoviva has US$4.80m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in US$254m. So we don't think Innoviva's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Innoviva you should be aware of.
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.
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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