Vifor Pharma (VTX:VIFN) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Vifor Pharma AG (VTX:VIFN) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Vifor Pharma

How Much Debt Does Vifor Pharma Carry?

As you can see below, Vifor Pharma had CHF539.8m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CHF734.4m in cash, so it actually has CHF194.6m net cash.

A Look At Vifor Pharma's Liabilities

According to the last reported balance sheet, Vifor Pharma had liabilities of CHF544.0m due within 12 months, and liabilities of CHF650.1m due beyond 12 months. On the other hand, it had cash of CHF734.4m and CHF492.4m worth of receivables due within a year. So it actually has CHF32.7m more liquid assets than total liabilities.

This state of affairs indicates that Vifor Pharma's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CHF8.23b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Vifor Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Vifor Pharma grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vifor Pharma'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Vifor Pharma 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. Looking at the most recent three years, Vifor Pharma recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Vifor Pharma has CHF194.6m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 14% in the last twelve months. So we don't think Vifor Pharma's use of debt is risky. 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. We've identified 1 warning sign with Vifor Pharma , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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