Is Jazz Pharmaceuticals (NASDAQ:JAZZ) a risky investment?

Howard Marks said that instead of worrying about stock price fluctuations, “the possibility of permanent loss is the risk I worry about…and every practicing investor I know worries about that.” He expressed it well. It’s only natural to consider a company’s balance sheet when you consider how risky it is, since debt is often involved when a business collapses.Like many other companies Jazz Pharmaceuticals PLC (NASDAQ:JAZZ) uses debt. But the real question is whether this debt is putting the company at risk.

Why does debt pose a risk?

Generally, debt only becomes a real problem if a company cannot easily pay it off, either by raising capital or with its own cash flow. Ultimately, if a company fails to meet its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, resulting in permanent shareholder dilution. However, as an alternative to dilution, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first think of cash and debt together.

Check out our latest analysis for Jazz Pharmaceuticals.

What is Jazz Pharmaceuticals’ net debt?

The graph below, which you can click on for greater detail, shows that Jazz Pharmaceuticals had debt of US$5.72b at September 2023. Almost the same as last year. However, he also had US$1.59b in cash, so his net debt is US$4.12b.

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$1.57b due within 12 months, and liabilities of US$6.14b due beyond that. Masu. Offsetting these obligations, the company had cash of US$1.59b and receivables valued at US$627.8m due within 12 months. So its liabilities total US$5.49b more than its cash and short-term receivables, combined.

This is huge leverage compared to its market capitalization of US$7.98 billion. Shareholders are likely to face serious dilution if lenders demand a stronger balance sheet.

We use two main ratios to determine debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), and the second is how much earnings before interest and tax (EBIT) covers interest expense (or interest cover, for short). It’s about how many times you cover it. . This way, we consider both the absolute amount of debt and the interest rate paid on it.

Jazz Pharmaceuticals’ net debt is a very reasonable 2.5x its EBITDA, but its EBIT was only 3.5x its interest expense over the last year. These numbers don’t surprise us, but it’s worth noting that the company’s cost of debt has a real impact. If Jazz Pharmaceuticals can continue to grow its EBIT at 11% YoY, its debt load will be easier to manage. The balance sheet is clearly the area to focus on when analyzing debt. But more than anything else, future earnings will determine whether Jazz Pharmaceuticals can maintain a healthy balance sheet going forward.If you’re focused on the future, check this out free A report showing analyst profit forecasts.

Finally, companies need free cash flow to pay down debt. Accounting profits alone are not enough. So the logical step is to look at the proportion of his EBIT that is matched by actual free cash flow. Over the last three years, Jazz Pharmaceuticals actually generated more free cash flow than its EBIT. There’s nothing better than having cash coming in to stay in the good graces of lenders.

our view

In terms of its balance sheet, a notable positive for Jazz Pharmaceuticals was the fact that it seems to be able to confidently convert EBIT to free cash flow. However, other observations were less encouraging. For example, it looks like the company will have to work a little harder to cover its interest expense with EBIT. Considering this range of data points, we think Jazz Pharmaceuticals is in a good position to manage its debt levels. Having said that, the burden is significant enough that we recommend shareholders keep an eye on it. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet, far from it.Case in point: we discovered 2 warning signs for Jazz Pharmaceuticals you should know.

At the end of the day, it’s often better to focus on companies with no net debt. You can access a special list of such companies (all with a track record of profit growth). It’s free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodologies, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.