H. Lundbeck (CPH:HLUN B) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, H. Lundbeck A/S (CPH:HLUN B) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for H. Lundbeck

What Is H. Lundbeck's Debt?

As you can see below, H. Lundbeck had kr.3.72b of debt at June 2024, down from kr.4.50b a year prior. However, its balance sheet shows it holds kr.6.15b in cash, so it actually has kr.2.44b net cash.

A Look At H. Lundbeck's Liabilities

The latest balance sheet data shows that H. Lundbeck had liabilities of kr.8.06b due within a year, and liabilities of kr.7.81b falling due after that. Offsetting these obligations, it had cash of kr.6.15b as well as receivables valued at kr.4.51b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.5.21b.

Since publicly traded H. Lundbeck shares are worth a total of kr.42.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, H. Lundbeck boasts net cash, so it's fair to say it does not have a heavy debt load!

While H. Lundbeck doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 H. Lundbeck 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While H. Lundbeck 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, H. Lundbeck actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although H. Lundbeck's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr.2.44b. And it impressed us with free cash flow of kr.4.1b, being 103% of its EBIT. So we don't think H. Lundbeck's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for H. Lundbeck you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.