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. We note that Orchard Therapeutics plc (NASDAQ:ORTX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Orchard Therapeutics Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Orchard Therapeutics had US$24.6m of debt, an increase on none, over one year. However, it does have US$366.2m in cash offsetting this, leading to net cash of US$341.5m.
How Strong Is Orchard Therapeutics's Balance Sheet?
We can see from the most recent balance sheet that Orchard Therapeutics had liabilities of US$44.3m falling due within a year, and liabilities of US$30.7m due beyond that. Offsetting these obligations, it had cash of US$366.2m as well as receivables valued at US$19.0m due within 12 months. So it actually has US$310.2m more liquid assets than total liabilities.
This excess liquidity suggests that Orchard Therapeutics is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Orchard Therapeutics has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Orchard Therapeutics's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Orchard Therapeutics reported revenue of US$2.6m, which is a gain of 88%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Orchard Therapeutics?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Orchard Therapeutics lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$153m and booked a US$143m accounting loss. But at least it has US$341.5m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Orchard Therapeutics may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Orchard Therapeutics (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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