We Think Pharming Group (AMS:PHARM) Can Manage Its Debt With Ease

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. Importantly, Pharming Group N.V. (AMS:PHARM) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Pharming Group

How Much Debt Does Pharming Group Carry?

As you can see below, at the end of June 2020, Pharming Group had €123.2m of debt, up from €58.9m a year ago. Click the image for more detail. But on the other hand it also has €152.8m in cash, leading to a €29.6m net cash position.

How Healthy Is Pharming Group's Balance Sheet?

We can see from the most recent balance sheet that Pharming Group had liabilities of €43.9m falling due within a year, and liabilities of €145.7m due beyond that. Offsetting these obligations, it had cash of €152.8m as well as receivables valued at €26.4m due within 12 months. So its liabilities total €10.4m more than the combination of its cash and short-term receivables.

Having regard to Pharming Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the €646.7m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Pharming Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Pharming Group grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Happily for any shareholders, Pharming Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Pharming Group has €29.6m in net cash. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in €52m. So we don't think Pharming Group's use of debt is risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with Pharming Group .

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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This article by Simply Wall St is general in nature. 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.
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