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 can see that XBiotech Inc. (NASDAQ:XBIT) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is XBiotech's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2024 XBiotech had debt of US$10.0m, up from none in one year. But it also has US$183.1m in cash to offset that, meaning it has US$173.1m net cash.
How Strong Is XBiotech's Balance Sheet?
The latest balance sheet data shows that XBiotech had liabilities of US$16.0m due within a year, and liabilities of US$1.74m falling due after that. Offsetting this, it had US$183.1m in cash and US$871.0k in receivables that were due within 12 months. So it can boast US$166.3m more liquid assets than total liabilities.
This surplus strongly suggests that XBiotech has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that XBiotech has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is XBiotech's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Since XBiotech 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 XBiotech?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that XBiotech 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$29m and booked a US$33m accounting loss. But the saving grace is the US$173.1m on the balance sheet. That means it could keep spending at its current rate for more than two years. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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 3 warning signs for XBiotech (2 are concerning!) 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
