Biotech stocks don't come with labels that warn investors of potential dangers ahead. There is something that comes close, though.
The current ratio is a key metric that measures the liquidity of a company. It compares the company's current assets to its current liabilities to evaluate if there are enough resources to pay debts over the next 12 months. A current ratio less than one indicates that a company might encounter liquidity problems in the near future. Here are three biotech stocks with potentially dangerous liquidity ratios -- but are they really in trouble?
MannKind Corp (NASDAQ:56400P706)
After years of regulatory obstacles, MannKind finally got its inhaled insulin product Afrezza on the market. However, the process of getting to that point has left the biotech in what some might say is a precarious financial position. MannKind's current ratio is low at 0.42, which in theory means the company's assets are only sufficient to pay its debt for another five months or so.
I used the words "in theory" because, while MannKind's liquidity ratio is dangerously low, the company's actual liquidity looks somewhat better. The biggest factor in the biotech's low current ratio stems from a $185 million liability -- deferred payments from MannKind's collaboration with Sanofi. MannKind received large up-front payments from Sanofi, but the company hasn't recognized this revenue yet for accounting reasons, and is instead listing the amounts as liabilities for now.
MannKind's management said in May that there should be sufficient resources to fund operations for another 12 months, provided that the company can convert into stock or refinance convertible notes maturing in August. Still, the biotech might have to raise more money to remain in operation. Raising additional cash hasn't proven too difficult for MannKind in the past, though.
Shire plc (NASDAQ:SHPG)
Ireland-based biopharmaceuticals firm Shire claims a current ratio of only 0.52. Shire's current assets of a little over $2.5 billion are dwarfed by current liabilities of nearly 4.9 billion.
The problem for Shire is that it has accumulated debt after gobbling up several other drugmakers over the last few years. Shire acquired NPS Pharma earlier this year. While Shire had $1.6 billion in its coffers after AbbVie walked away from a potential buyout deal, the NPS price tag topped $5.2 billion. Shire's short-term debt load after buying NPS Pharma now stands above $2.5 billion.
Is Shire really in danger of running out of money? There's no need to worry, according to the company's management. While Shire only has $74.3 million in cash and cash equivalents, it boasts something that MannKind can't: profits. Last year, Shire generated earnings of more than $3.4 billion.
In addition to a healthy bottom line, Shire also has a revolving credit facility with around $1.2 billion still available. Despite the seemingly precariously low liquidity ratio, Shire doesn't appear to be at risk of any imminent financial woes.
Navidea BioPharmaceuticals (NYSEMKT:NAVB)
Then there's Navidea. The biotech operates in the growing area of precision medicine with its diagnostics, therapeutics, and radiopharmaceutical agents. However, Navidea's current ratio is a potentially problematic 0.62.
In Navidea's case, a high accounts payable balance is almost as significant of an issue as its debt load. Unlike Shire, Navidea can't count on positive net income yet -- despite growing sales of its Lymphoseek radiopharmaceutical, used for lymphatic mapping in breast cancer and melanoma patients.
What can the company do to avoid serious issues in the months ahead? Navidea is looking to find additional collaboration and grant funding to help fund development. It is also attempting to trim expenses. Ultimately, though, Navidea could be forced to either borrow more money and/or issue more shares to raise money.
As you might have guessed by now, liquidity ratios don't necessarily tell the full story of a company's actual liquidity position. Investors need to dig deeper to understand how well a given company can pay its bills.
Examining the balance sheet is important, but paying attention to the income statement is as well. Shire's strong earnings, for example, should lessen concerns about its low current ratio. Sometimes, as in MannKind's case, the company isn't in great financial shape, but the situation isn't as dire as the low liquidity ratio might imply. And in other cases like Navidea's, a company must take action to prevent serious problems.
Liquidity ratios can be a tool for investors to evaluate a company's financial health, but they're just one of many tools to use. Unfortunately, stocks -- especially biotech stocks -- don't come with simple warning labels.
Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.