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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Orexo AB (publ) (STO:ORX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Orexo's Net Debt?
The image below, which you can click on for greater detail, shows that Orexo had debt of kr289.2m at the end of September 2019, a reduction from kr320.2m over a year. But on the other hand it also has kr812.9m in cash, leading to a kr523.7m net cash position.
How Healthy Is Orexo's Balance Sheet?
According to the last reported balance sheet, Orexo had liabilities of kr537.9m due within 12 months, and liabilities of kr335.7m due beyond 12 months. Offsetting these obligations, it had cash of kr812.9m as well as receivables valued at kr286.4m due within 12 months. So it actually has kr225.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Orexo could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Orexo boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Orexo has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. 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 Orexo'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Orexo 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. Happily for any shareholders, Orexo actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Orexo has kr523.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of kr286m, being 172% of its EBIT. So is Orexo's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Orexo would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
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.
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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