Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Clinigen Group plc (LON:CLIN) does carry debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Clinigen Group Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Clinigen Group had debt of UK£388.5m, up from UK£345.0m in one year. However, it also had UK£62.9m in cash, and so its net debt is UK£325.6m.
How Strong Is Clinigen Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Clinigen Group had liabilities of UK£136.2m due within 12 months and liabilities of UK£447.6m due beyond that. On the other hand, it had cash of UK£62.9m and UK£116.9m worth of receivables due within a year. So it has liabilities totalling UK£404.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Clinigen Group is worth UK£1.13b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Clinigen Group's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 5.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Unfortunately, Clinigen Group saw its EBIT slide 5.1% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Clinigen Group'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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Clinigen Group recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Clinigen Group's EBIT growth rate does give us pause, its conversion of EBIT to free cash flow and interest cover suggest it can stay on top of its debt load. Looking at all the angles mentioned above, it does seem to us that Clinigen Group is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Clinigen Group is showing 2 warning signs in our investment analysis , 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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