Is Pharming Group (AMS:PHARM) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Pharming Group N.V. (AMS:PHARM) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Pharming Group

What Is Pharming Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Pharming Group had €123.2m in debt in September 2021; about the same as the year before. However, it does have €158.0m in cash offsetting this, leading to net cash of €34.9m.

A Look At Pharming Group's Liabilities

According to the last reported balance sheet, Pharming Group had liabilities of €40.3m due within 12 months, and liabilities of €138.5m due beyond 12 months. Offsetting this, it had €158.0m in cash and €28.3m in receivables that were due within 12 months. So it can boast €7.54m more liquid assets than total liabilities.

This state of affairs indicates that Pharming Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the €520.3m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Pharming Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Pharming Group's saving grace is its low debt levels, because its EBIT has tanked 62% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Pharming Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Pharming Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Pharming Group recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Pharming Group has net cash of €34.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of €25m, being 88% of its EBIT. So we are not troubled with Pharming Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Pharming Group that you should be aware of before investing here.

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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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.