Is Santhera Pharmaceuticals Holding (VTX:SANN) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Santhera Pharmaceuticals Holding AG (VTX:SANN) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Santhera Pharmaceuticals Holding

How Much Debt Does Santhera Pharmaceuticals Holding Carry?

You can click the graphic below for the historical numbers, but it shows that Santhera Pharmaceuticals Holding had CHF23.7m of debt in June 2024, down from CHF40.6m, one year before. On the flip side, it has CHF16.5m in cash leading to net debt of about CHF7.17m.

A Look At Santhera Pharmaceuticals Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that Santhera Pharmaceuticals Holding had liabilities of CHF53.1m due within 12 months and liabilities of CHF7.14m due beyond that. On the other hand, it had cash of CHF16.5m and CHF10.4m worth of receivables due within a year. So its liabilities total CHF33.3m more than the combination of its cash and short-term receivables.

Santhera Pharmaceuticals Holding has a market capitalization of CHF119.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

While Santhera Pharmaceuticals Holding's low debt to EBITDA ratio of 0.13 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.3 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Santhera Pharmaceuticals Holding made a loss at the EBIT level, last year, but improved that to positive EBIT of CHF54m in the last twelve months. 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 Santhera Pharmaceuticals Holding's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Santhera Pharmaceuticals Holding recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Santhera Pharmaceuticals Holding was the fact that it seems able handle its debt, based on its EBITDA, confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Santhera Pharmaceuticals Holding's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Santhera Pharmaceuticals Holding you should know about.

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.