Is Pharming Group (AMS:PHARM) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Pharming Group N.V. (AMS:PHARM) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Pharming Group

How Much Debt Does Pharming Group Carry?

As you can see below, Pharming Group had US$137.4m of debt at March 2022, down from US$144.1m a year prior. However, it does have US$189.7m in cash offsetting this, leading to net cash of US$52.3m.

How Healthy Is Pharming Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pharming Group had liabilities of US$45.2m due within 12 months and liabilities of US$153.6m due beyond that. On the other hand, it had cash of US$189.7m and US$31.4m worth of receivables due within a year. So it can boast US$22.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Pharming Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Pharming Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Pharming Group's EBIT was down 67% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pharming Group 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Pharming Group generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd 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 US$52.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in US$17m. 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. To that end, you should be aware of the 2 warning signs we've spotted with Pharming Group .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.