Pharma Mar (BME:PHM) Has A Rock Solid Balance Sheet

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 should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for Pharma Mar

What Is Pharma Mar's Net Debt?

The image below, which you can click on for greater detail, shows that Pharma Mar had debt of €59.5m at the end of June 2020, a reduction from €89.6m over a year. But on the other hand it also has €228.1m in cash, leading to a €168.7m net cash position.

How Healthy Is Pharma Mar's Balance Sheet?

According to the last reported balance sheet, Pharma Mar had liabilities of €108.4m due within 12 months, and liabilities of €140.3m due beyond 12 months. Offsetting this, it had €228.1m in cash and €18.2m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Pharma Mar's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the €1.63b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Pharma Mar also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Pharma Mar turned things around in the last 12 months, delivering and EBIT of €111m. 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, a company can only pay off debt with cold hard cash, not accounting profits. Pharma Mar may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Pharma Mar actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Pharma Mar has €168.7m in net cash. And it impressed us with free cash flow of €253m, being 227% of its EBIT. So is Pharma Mar's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Pharma Mar you should be aware of, and 1 of them is a bit unpleasant.

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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