Collegium Pharmaceutical (NASDAQ:COLL) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Collegium Pharmaceutical, Inc. (NASDAQ:COLL) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Collegium Pharmaceutical

What Is Collegium Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that Collegium Pharmaceutical had debt of US$623.1m at the end of March 2024, a reduction from US$798.3m over a year. However, it does have US$318.0m in cash offsetting this, leading to net debt of about US$305.1m.

How Healthy Is Collegium Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Collegium Pharmaceutical had liabilities of US$446.4m due within 12 months and liabilities of US$445.6m due beyond that. On the other hand, it had cash of US$318.0m and US$174.7m worth of receivables due within a year. So its liabilities total US$399.3m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Collegium Pharmaceutical has a market capitalization of US$1.06b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Collegium Pharmaceutical's low debt to EBITDA ratio of 0.89 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.2 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Collegium Pharmaceutical grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Collegium Pharmaceutical 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Collegium Pharmaceutical actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Collegium Pharmaceutical's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. When we consider the range of factors above, it looks like Collegium Pharmaceutical is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. We've identified 2 warning signs with Collegium Pharmaceutical , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.