David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Supernus Pharmaceuticals, Inc. (NASDAQ:SUPN) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Supernus Pharmaceuticals had debt of US$366.0m, up from US$349.2m in one year. But on the other hand it also has US$391.1m in cash, leading to a US$25.1m net cash position.

A Look At Supernus Pharmaceuticals’ Liabilities

Zooming in on the latest balance sheet data, we can see that Supernus Pharmaceuticals had liabilities of US$240.8m due within 12 months and liabilities of US$512.2m due beyond that. Offsetting these obligations, it had cash of US$391.1m as well as receivables valued at US$127.1m due within 12 months. So its liabilities total US$234.8m more than the combination of its cash and short-term receivables.

Since publicly traded Supernus Pharmaceuticals shares are worth a total of US$1.61b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Supernus Pharmaceuticals boasts net cash, so it’s fair to say it does not have a heavy debt load!

And we also note warmly that Supernus Pharmaceuticals grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Supernus Pharmaceuticals’s ability to maintain a healthy balance sheet going forward.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 puts it in a very strong position to pay down debt.

Summing up

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. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in US$163m. So we don’t think Supernus Pharmaceuticals’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it.