Celon Pharma (WSE:CLN) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Celon Pharma S.A. (WSE:CLN) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Celon Pharma

How Much Debt Does Celon Pharma Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Celon Pharma had debt of zł12.8m, up from none in one year. However, its balance sheet shows it holds zł44.0m in cash, so it actually has zł31.1m net cash.

A Look At Celon Pharma's Liabilities

Zooming in on the latest balance sheet data, we can see that Celon Pharma had liabilities of zł70.6m due within 12 months and liabilities of zł198.4m due beyond that. On the other hand, it had cash of zł44.0m and zł42.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł183.0m.

Given Celon Pharma has a market capitalization of zł2.07b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Celon Pharma also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Celon Pharma grew its EBIT by 497% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Celon Pharma 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. While Celon Pharma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Celon Pharma burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

We could understand if investors are concerned about Celon Pharma's liabilities, but we can be reassured by the fact it has has net cash of zł31.1m. And it impressed us with its EBIT growth of 497% over the last year. So we don't have any problem with Celon Pharma'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. For example - Celon Pharma has 1 warning sign we think 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.

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