These 4 Measures Indicate That Profarma Distribuidora de Produtos Farmacêuticos (BVMF:PFRM3) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Profarma Distribuidora de Produtos Farmacêuticos S.A. (BVMF:PFRM3) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Profarma Distribuidora de Produtos Farmacêuticos

How Much Debt Does Profarma Distribuidora de Produtos Farmacêuticos Carry?

As you can see below, Profarma Distribuidora de Produtos Farmacêuticos had R$694.3m of debt at March 2023, down from R$725.7m a year prior. However, because it has a cash reserve of R$167.5m, its net debt is less, at about R$526.8m.

How Strong Is Profarma Distribuidora de Produtos Farmacêuticos' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Profarma Distribuidora de Produtos Farmacêuticos had liabilities of R$2.47b due within 12 months and liabilities of R$822.6m due beyond that. On the other hand, it had cash of R$167.5m and R$1.69b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.43b.

The deficiency here weighs heavily on the R$478.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Profarma Distribuidora de Produtos Farmacêuticos would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though Profarma Distribuidora de Produtos Farmacêuticos's debt is only 1.8, its interest cover is really very low at 1.8. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Importantly, Profarma Distribuidora de Produtos Farmacêuticos grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Profarma Distribuidora de Produtos Farmacêuticos will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Profarma Distribuidora de Produtos Farmacêuticos recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Profarma Distribuidora de Produtos Farmacêuticos's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that Profarma Distribuidora de Produtos Farmacêuticos is in the Healthcare industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Profarma Distribuidora de Produtos Farmacêuticos's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Profarma Distribuidora de Produtos Farmacêuticos you should know about.

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.