Is Shedir Pharma Group (BIT:SHE) Using Too Much Debt?

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.' 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. We note that Shedir Pharma Group S.p.A. (BIT:SHE) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Shedir Pharma Group

How Much Debt Does Shedir Pharma Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Shedir Pharma Group had debt of €12.0m, up from €9.09m in one year. However, it does have €16.4m in cash offsetting this, leading to net cash of €4.42m.

A Look At Shedir Pharma Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Shedir Pharma Group had liabilities of €12.6m due within 12 months and liabilities of €13.3m due beyond that. Offsetting this, it had €16.4m in cash and €9.99m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Shedir Pharma Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €44.6m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Shedir Pharma Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Shedir Pharma Group saw its EBIT decline by 8.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shedir Pharma Group's ability to maintain a healthy balance sheet going forward. 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 Shedir Pharma Group 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 three years, Shedir Pharma Group reported free cash flow worth 4.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Shedir Pharma Group has net cash of €4.42m, as well as more liquid assets than liabilities. So we don't have any problem with Shedir Pharma Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 3 warning signs for Shedir Pharma Group (of which 1 is a bit unpleasant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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