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 can see that Supernus Pharmaceuticals, Inc. (NASDAQ:SUPN) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Supernus Pharmaceuticals's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Supernus Pharmaceuticals had US$366.0m of debt, an increase on US$349.2m, over one year. But it also has US$391.1m in cash to offset that, meaning it has US$25.1m net cash.
A Look At Supernus Pharmaceuticals' Liabilities
According to the last reported balance sheet, Supernus Pharmaceuticals had liabilities of US$240.8m due within 12 months, and liabilities of US$512.2m due beyond 12 months. Offsetting this, it had US$391.1m in cash and US$127.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$234.8m.
Given Supernus Pharmaceuticals has a market capitalization of US$1.58b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Supernus Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Supernus Pharmaceuticals grew its EBIT at 13% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Supernus 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Supernus Pharmaceuticals may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Supernus Pharmaceuticals generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Although Supernus Pharmaceuticals's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$25.1m. And it impressed us with free cash flow of US$163m, being 86% of its EBIT. So is Supernus Pharmaceuticals's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Supernus Pharmaceuticals you should be aware of.
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.
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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