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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Nephros, Inc. (NASDAQ:NEPH) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Nephros's Net Debt?
As you can see below, at the end of June 2019, Nephros had US$1.95m of debt, up from US$1.29m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$4.32m in cash, so it actually has US$2.36m net cash.
How Healthy Is Nephros's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nephros had liabilities of US$3.29m due within 12 months and liabilities of US$1.92m due beyond that. Offsetting these obligations, it had cash of US$4.32m as well as receivables valued at US$1.54m due within 12 months. So it actually has US$649.0k more liquid assets than total liabilities.
Having regard to Nephros's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$53.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Nephros has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nephros 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.
In the last year Nephros managed to grow its revenue by 62%, to US$7.4m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Nephros?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Nephros lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$3.7m of cash and made a loss of US$3.7m. But at least it has US$4.3m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Nephros may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Nephros insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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