Health Check: How Prudently Does Pharmesis International (SGX:BFK) Use Debt?

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.' 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 Pharmesis International Ltd. (SGX:BFK) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Pharmesis International

How Much Debt Does Pharmesis International Carry?

The chart below, which you can click on for greater detail, shows that Pharmesis International had CN¥15.0m in debt in December 2020; about the same as the year before. However, its balance sheet shows it holds CN¥15.2m in cash, so it actually has CN¥187.0k net cash.

How Healthy Is Pharmesis International's Balance Sheet?

The latest balance sheet data shows that Pharmesis International had liabilities of CN¥32.4m due within a year, and liabilities of CN¥667.0k falling due after that. Offsetting this, it had CN¥15.2m in cash and CN¥12.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.17m.

This deficit isn't so bad because Pharmesis International is worth CN¥24.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Pharmesis International boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Pharmesis International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Pharmesis International wasn't profitable at an EBIT level, but managed to grow its revenue by 27%, to CN¥47m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Pharmesis International?

While Pharmesis International lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥773k. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that Pharmesis International is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock 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. For instance, we've identified 2 warning signs for Pharmesis International that 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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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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