Cosmo Pharmaceuticals (VTX:COPN) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Cosmo Pharmaceuticals N.V. (VTX:COPN) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Cosmo Pharmaceuticals

How Much Debt Does Cosmo Pharmaceuticals Carry?

The chart below, which you can click on for greater detail, shows that Cosmo Pharmaceuticals had €163.2m in debt in December 2020; about the same as the year before. However, it does have €212.9m in cash offsetting this, leading to net cash of €49.7m.

A Look At Cosmo Pharmaceuticals' Liabilities

We can see from the most recent balance sheet that Cosmo Pharmaceuticals had liabilities of €21.8m falling due within a year, and liabilities of €174.2m due beyond that. Offsetting this, it had €212.9m in cash and €28.1m in receivables that were due within 12 months. So it can boast €45.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Cosmo Pharmaceuticals could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cosmo Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.

We also note that Cosmo Pharmaceuticals improved its EBIT from a last year's loss to a positive €1.8m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cosmo Pharmaceuticals 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Cosmo Pharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Cosmo Pharmaceuticals actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Cosmo Pharmaceuticals has €49.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of €4.9m, being 271% of its EBIT. So we are not troubled with Cosmo Pharmaceuticals's debt use. 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 - Cosmo Pharmaceuticals has 1 warning sign we think you should be aware of.

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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