Allergy Therapeutics (LON:AGY) Has A Pretty Healthy Balance Sheet
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 Allergy Therapeutics plc (LON:AGY) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Allergy Therapeutics
What Is Allergy Therapeutics's Net Debt?
As you can see below, Allergy Therapeutics had UK£1.98m of debt at December 2019, down from UK£2.76m a year prior. However, it does have UK£39.7m in cash offsetting this, leading to net cash of UK£37.7m.
How Strong Is Allergy Therapeutics's Balance Sheet?
According to the last reported balance sheet, Allergy Therapeutics had liabilities of UK£15.0m due within 12 months, and liabilities of UK£21.7m due beyond 12 months. On the other hand, it had cash of UK£39.7m and UK£8.77m worth of receivables due within a year. So it actually has UK£11.8m more liquid assets than total liabilities.
This surplus suggests that Allergy Therapeutics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Allergy Therapeutics has more cash than debt is arguably a good indication that it can manage its debt safely.
We also note that Allergy Therapeutics improved its EBIT from a last year's loss to a positive UK£219k. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Allergy Therapeutics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Allergy Therapeutics 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. Over the last year, Allergy Therapeutics actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Allergy Therapeutics has net cash of UK£37.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 4450% of that EBIT to free cash flow, bringing in UK£9.7m. So is Allergy Therapeutics's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Allergy Therapeutics (1 can't be ignored) you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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