Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Mereo BioPharma Group plc (NASDAQ:MREO) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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.
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How Much Debt Does Mereo BioPharma Group Carry?
The image below, which you can click on for greater detail, shows that Mereo BioPharma Group had debt of UK£16.0m at the end of June 2022, a reduction from UK£17.9m over a year. However, its balance sheet shows it holds UK£76.4m in cash, so it actually has UK£60.5m net cash.
How Strong Is Mereo BioPharma Group’s Balance Sheet?
We can see from the most recent balance sheet that Mereo BioPharma Group had liabilities of UK£35.2m falling due within a year, and liabilities of UK£3.24m due beyond that. On the other hand, it had cash of UK£76.4m and UK£2.65m worth of receivables due within a year. So it actually has UK£40.6m more liquid assets than total liabilities.
This luscious liquidity implies that Mereo BioPharma Group’s balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Mereo BioPharma Group has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Mereo BioPharma Group 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.
Given its lack of meaningful operating revenue, Mereo BioPharma Group shareholders no doubt hope it can fund itself until it has a profitable product.
So How Risky Is Mereo BioPharma Group?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Mereo BioPharma Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of UK£33m and booked a UK£19m accounting loss. With only UK£60.5m on the balance sheet, it would appear that its going to need to raise capital again soon. 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. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Mereo BioPharma Group is showing 2 warning signs in our investment analysis and 1 of those is potentially serious…
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.