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.’ 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 Enanta Pharmaceuticals, Inc. (NASDAQ:ENTA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Enanta Pharmaceuticals’s Net Debt?
As you can see below, Enanta Pharmaceuticals had US$1.51m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$280.3m in cash, leading to a US$278.8m net cash position.
How Strong Is Enanta Pharmaceuticals’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Enanta Pharmaceuticals had liabilities of US$30.7m due within 12 months and liabilities of US$17.5m due beyond that. Offsetting these obligations, it had cash of US$280.3m as well as receivables valued at US$47.5m due within 12 months. So it actually has US$279.6m more liquid assets than total liabilities.
This surplus suggests that Enanta Pharmaceuticals is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Enanta Pharmaceuticals boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Enanta Pharmaceuticals’s ability to maintain a healthy balance sheet going forward.
In the last year Enanta Pharmaceuticals had a loss before interest and tax, and actually shrunk its revenue by 2.8%, to US$92m. That’s not what we would hope to see.
So How Risky Is Enanta Pharmaceuticals?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Enanta Pharmaceuticals had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$91m and booked a US$112m accounting loss. Given it only has net cash of US$278.8m, the company may need to raise more capital if it doesn’t reach break-even soon. Overall, its balance sheet doesn’t seem overly risky, at the moment, but we’re always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt.
