Is Pharma Mar (BME:PHM) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Pharma Mar, S.A. (BME:PHM) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Pharma Mar

What Is Pharma Mar's Net Debt?

As you can see below, Pharma Mar had €50.7m of debt at September 2021, down from €56.9m a year prior. But on the other hand it also has €221.1m in cash, leading to a €170.4m net cash position.

How Healthy Is Pharma Mar's Balance Sheet?

According to the last reported balance sheet, Pharma Mar had liabilities of €81.4m due within 12 months, and liabilities of €123.0m due beyond 12 months. On the other hand, it had cash of €221.1m and €26.0m worth of receivables due within a year. So it can boast €42.7m 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!

The modesty of its debt load may become crucial for Pharma Mar if management cannot prevent a repeat of the 51% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pharma Mar's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the last two years, Pharma Mar actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Pharma Mar has €170.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 142% of that EBIT to free cash flow, bringing in €29m. So we don't have any problem with Pharma Mar's use of debt. 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 you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.