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.' 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, Kezar Life Sciences, Inc. (NASDAQ:KZR) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Kezar Life Sciences Carry?
As you can see below, at the end of June 2022, Kezar Life Sciences had US$9.73m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$306.8m in cash, leading to a US$297.1m net cash position.
How Strong Is Kezar Life Sciences' Balance Sheet?
The latest balance sheet data shows that Kezar Life Sciences had liabilities of US$7.85m due within a year, and liabilities of US$12.3m falling due after that. Offsetting these obligations, it had cash of US$306.8m as well as receivables valued at US$70.0k due within 12 months. So it can boast US$286.8m more liquid assets than total liabilities.
This surplus liquidity suggests that Kezar Life Sciences' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Kezar Life Sciences has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Kezar Life Sciences can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Since Kezar Life Sciences doesn't have significant operating revenue, shareholders may be hoping it comes up with a great new product, before it runs out of money.
So How Risky Is Kezar Life Sciences?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Kezar Life Sciences had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$49m and booked a US$61m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$297.1m. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 5 warning signs we've spotted with Kezar Life Sciences (including 2 which shouldn't be ignored) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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