Is Sumitomo Pharma (TSE:4506) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Sumitomo Pharma Co., Ltd. (TSE:4506) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sumitomo Pharma

How Much Debt Does Sumitomo Pharma Carry?

You can click the graphic below for the historical numbers, but it shows that Sumitomo Pharma had JP¥374.4b of debt in December 2024, down from JP¥411.8b, one year before. However, it also had JP¥85.4b in cash, and so its net debt is JP¥289.0b.

How Strong Is Sumitomo Pharma's Balance Sheet?

The latest balance sheet data shows that Sumitomo Pharma had liabilities of JP¥499.3b due within a year, and liabilities of JP¥186.7b falling due after that. On the other hand, it had cash of JP¥85.4b and JP¥97.3b worth of receivables due within a year. So it has liabilities totalling JP¥503.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the JP¥286.8b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Sumitomo Pharma would probably need a major re-capitalization if its creditors were to demand repayment. 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 Sumitomo Pharma can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Sumitomo Pharma wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to JP¥373b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Sumitomo Pharma produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping JP¥224b. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through JP¥21b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Sumitomo Pharma that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.