Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 Avadel Pharmaceuticals plc (NASDAQ:AVDL) does use debt in its business. But is this debt a concern to shareholders?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

How Much Debt Does Avadel Pharmaceuticals Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Avadel Pharmaceuticals had debt of US$141.5m, up from US$123.3m in one year. But it also has US$206.5m in cash to offset that, meaning it has US$65.0m net cash.

How Healthy Is Avadel Pharmaceuticals’ Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Avadel Pharmaceuticals had liabilities of US$9.12m due within 12 months and liabilities of US$147.3m due beyond that. On the other hand, it had cash of US$206.5m and US$30.5m worth of receivables due within a year. So it actually has US$80.5m more liquid assets than total liabilities.

This excess liquidity suggests that Avadel Pharmaceuticals is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Avadel Pharmaceuticals 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 Avadel Pharmaceuticals’s ability to maintain a healthy balance sheet going forward.

Over 12 months, Avadel Pharmaceuticals made a loss at the EBIT level, and saw its revenue drop to US$10m, which is a fall of 82%. That makes us nervous, to say the least.

So How Risky Is Avadel Pharmaceuticals?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Avadel Pharmaceuticals lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$61m of cash and made a loss of US$5.6m. But the saving grace is the US$65.0m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn’t produce free cash flow regularly.