Hikma Pharmaceuticals (LON:HIK) 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.' 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. We can see that Hikma Pharmaceuticals PLC (LON:HIK) does use debt in its business. 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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hikma Pharmaceuticals

How Much Debt Does Hikma Pharmaceuticals Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Hikma Pharmaceuticals had US$850.0m of debt, an increase on US$617.0m, over one year. On the flip side, it has US$347.0m in cash leading to net debt of about US$503.0m.

A Look At Hikma Pharmaceuticals' Liabilities

According to the last reported balance sheet, Hikma Pharmaceuticals had liabilities of US$1.03b due within 12 months, and liabilities of US$959.0m due beyond 12 months. Offsetting these obligations, it had cash of US$347.0m as well as receivables valued at US$733.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$907.0m.

Of course, Hikma Pharmaceuticals has a market capitalization of US$7.78b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Hikma Pharmaceuticals has a low net debt to EBITDA ratio of only 0.73. And its EBIT easily covers its interest expense, being 16.8 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Hikma Pharmaceuticals grew its EBIT by 18% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hikma Pharmaceuticals'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hikma Pharmaceuticals produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Hikma Pharmaceuticals's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Hikma Pharmaceuticals seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Hikma Pharmaceuticals, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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