Is Open Orphan (LON:ORPH) A Risky Investment?

Simply Wall St

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. We note that Open Orphan plc (LON:ORPH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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.

View our latest analysis for Open Orphan

What Is Open Orphan's Net Debt?

As you can see below, Open Orphan had UK£1.32m of debt at June 2020, down from UK£1.75m a year prior. But on the other hand it also has UK£14.7m in cash, leading to a UK£13.3m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Open Orphan's Balance Sheet?

According to the last reported balance sheet, Open Orphan had liabilities of UK£6.71m due within 12 months, and liabilities of UK£2.27m due beyond 12 months. On the other hand, it had cash of UK£14.7m and UK£2.62m worth of receivables due within a year. So it can boast UK£8.29m more liquid assets than total liabilities.

This short term liquidity is a sign that Open Orphan could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Open Orphan 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 ultimately the future profitability of the business will decide if Open Orphan 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.

In the last year Open Orphan managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.

So How Risky Is Open Orphan?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Open Orphan had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of UK£6.2m and booked a UK£11m accounting loss. Given it only has net cash of UK£13.3m, the company may need to raise more capital if it doesn't reach break-even 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 analysing 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. For example, we've discovered 3 warning signs for Open Orphan (1 doesn't sit too well with us!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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. 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 (at) simplywallst.com.

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