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.' 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. As with many other companies Verona Pharma plc (NASDAQ:VRNA) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Verona Pharma's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Verona Pharma had US$48.5m of debt, an increase on US$19.8m, over one year. However, its balance sheet shows it holds US$254.9m in cash, so it actually has US$206.3m net cash.

How Healthy Is Verona Pharma's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Verona Pharma had liabilities of US$14.8m due within 12 months and liabilities of US$50.2m due beyond that. On the other hand, it had cash of US$254.9m and US$11.5m worth of receivables due within a year. So it actually has US$201.4m more liquid assets than total liabilities.

This surplus suggests that Verona Pharma is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Verona Pharma boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Verona Pharma 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.

It seems likely shareholders hope that Verona Pharma can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

So How Risky Is Verona Pharma?

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 Verona Pharma had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through US$58m of cash and made a loss of US$63m. But the saving grace is the US$206.3m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. 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. 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. Be aware that Verona Pharma is showing 1 warning sign in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com