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 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 note that Reata Pharmaceuticals, Inc. (NASDAQ:RETA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Reata Pharmaceuticals's Debt?
As you can see below, Reata Pharmaceuticals had US$79.9m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. But it also has US$280.4m in cash to offset that, meaning it has US$200.6m net cash.
How Strong Is Reata Pharmaceuticals's Balance Sheet?
We can see from the most recent balance sheet that Reata Pharmaceuticals had liabilities of US$67.7m falling due within a year, and liabilities of US$266.3m due beyond that. Offsetting this, it had US$280.4m in cash and US$30.5m in receivables that were due within 12 months. So its liabilities total US$23.1m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Reata Pharmaceuticals's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$2.50b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Reata Pharmaceuticals also has more cash than debt, so we're pretty confident 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 Reata Pharmaceuticals 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.
Over 12 months, Reata Pharmaceuticals saw its revenue drop to US$28m, which is a fall of 54%. That makes us nervous, to say the least.
So How Risky Is Reata Pharmaceuticals?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Reata Pharmaceuticals lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$98m and booked a US$120m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$280m. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. For riskier companies like Reata Pharmaceuticals I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.