Galenica (VTX:GALE) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Galenica AG (VTX:GALE) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Galenica

What Is Galenica's Net Debt?

The chart below, which you can click on for greater detail, shows that Galenica had CHF424.7m in debt in December 2021; about the same as the year before. On the flip side, it has CHF165.0m in cash leading to net debt of about CHF259.7m.

How Healthy Is Galenica's Balance Sheet?

According to the last reported balance sheet, Galenica had liabilities of CHF664.9m due within 12 months, and liabilities of CHF667.4m due beyond 12 months. Offsetting this, it had CHF165.0m in cash and CHF461.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF706.2m.

Since publicly traded Galenica shares are worth a total of CHF3.57b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Galenica has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 44.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Galenica grew its EBIT at 17% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Galenica's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Galenica actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Galenica's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It's also worth noting that Galenica is in the Healthcare industry, which is often considered to be quite defensive. Overall, we don't think Galenica is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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. For example, we've discovered 1 warning sign for Galenica that you should be aware of before investing here.

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.

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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.