Here's Why Pharma Mar (BME:PHM) Has A Meaningful Debt Burden

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.' 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. Importantly, Pharma Mar, S.A. (BME:PHM) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Pharma Mar

How Much Debt Does Pharma Mar Carry?

The chart below, which you can click on for greater detail, shows that Pharma Mar had €39.7m in debt in September 2023; about the same as the year before. However, it does have €174.4m in cash offsetting this, leading to net cash of €134.7m.

How Healthy Is Pharma Mar's Balance Sheet?

According to the last reported balance sheet, Pharma Mar had liabilities of €86.6m due within 12 months, and liabilities of €56.6m due beyond 12 months. On the other hand, it had cash of €174.4m and €30.2m worth of receivables due within a year. So it can boast €61.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Pharma Mar could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Pharma Mar boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Pharma Mar's EBIT was down 90% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pharma Mar can strengthen its balance sheet over time. 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. While Pharma Mar 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. In the last three years, Pharma Mar created free cash flow amounting to 16% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Pharma Mar has €134.7m in net cash and a decent-looking balance sheet. So while Pharma Mar does not have a great balance sheet, it's certainly not too bad. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Pharma Mar (of which 1 is a bit concerning!) you should know about.

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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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.