Pharming Group (AMS:PHARM) Seems To Use Debt Quite Sensibly

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.' 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 Pharming Group N.V. (AMS:PHARM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Pharming Group

How Much Debt Does Pharming Group Carry?

The chart below, which you can click on for greater detail, shows that Pharming Group had €122.8m in debt in March 2021; about the same as the year before. But it also has €175.9m in cash to offset that, meaning it has €53.1m net cash.

How Strong Is Pharming Group's Balance Sheet?

We can see from the most recent balance sheet that Pharming Group had liabilities of €62.9m falling due within a year, and liabilities of €127.0m due beyond that. Offsetting this, it had €175.9m in cash and €28.1m in receivables that were due within 12 months. So it can boast €14.2m 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.

It is just as well that Pharming Group's load is not too heavy, because its EBIT was down 25% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pharming 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.

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. Over the last three years, Pharming Group recorded free cash flow worth a fulsome 91% 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 it is always sensible to investigate a company's debt, in this case Pharming Group has €53.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in €51m. So we don't have any problem with Pharming Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Pharming Group is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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