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.' 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 Jazz Pharmaceuticals plc (NASDAQ:JAZZ) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Jazz Pharmaceuticals's Debt?
As you can see below, at the end of December 2020, Jazz Pharmaceuticals had US$2.10b of debt, up from US$1.61b a year ago. Click the image for more detail. But on the other hand it also has US$2.13b in cash, leading to a US$35.1m net cash position.
How Strong Is Jazz Pharmaceuticals' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Jazz Pharmaceuticals had liabilities of US$653.7m due within 12 months and liabilities of US$2.22b due beyond that. On the other hand, it had cash of US$2.13b and US$396.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$346.9m.
Of course, Jazz Pharmaceuticals has a market capitalization of US$9.47b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Jazz Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Jazz Pharmaceuticals grew its EBIT by 19% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jazz Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Jazz Pharmaceuticals 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. Over the last three years, Jazz Pharmaceuticals recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
We could understand if investors are concerned about Jazz Pharmaceuticals's liabilities, but we can be reassured by the fact it has has net cash of US$35.1m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$520m. So we don't think Jazz Pharmaceuticals's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Jazz Pharmaceuticals that you should be aware of before investing here.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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