We Think Pharmanutra (BIT:PHN) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Pharmanutra S.p.A. (BIT:PHN) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Pharmanutra

What Is Pharmanutra's Net Debt?

The image below, which you can click on for greater detail, shows that Pharmanutra had debt of €5.34m at the end of December 2018, a reduction from €5.61m over a year. But on the other hand it also has €15.8m in cash, leading to a €10.5m net cash position.

How Healthy Is Pharmanutra's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pharmanutra had liabilities of €13.0m due within 12 months and liabilities of €4.06m due beyond that. Offsetting these obligations, it had cash of €15.8m as well as receivables valued at €15.4m due within 12 months. So it actually has €14.2m more liquid assets than total liabilities.

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

On top of that, Pharmanutra grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pharmanutra 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 Pharmanutra 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. During the last three years, Pharmanutra produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Pharmanutra has €10m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 35% over the last year. So we don't think Pharmanutra's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Pharmanutra's earnings per share history for free.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.