Stock Analysis

These 4 Measures Indicate That Amneal Pharmaceuticals (NYSE:AMRX) Is Using Debt Extensively

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NYSE:AMRX
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Amneal Pharmaceuticals, Inc. (NYSE:AMRX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Amneal Pharmaceuticals

What Is Amneal Pharmaceuticals's Net Debt?

As you can see below, at the end of September 2020, Amneal Pharmaceuticals had US$2.88b of debt, up from US$2.64b a year ago. Click the image for more detail. On the flip side, it has US$282.0m in cash leading to net debt of about US$2.60b.

debt-equity-history-analysis
NYSE:AMRX Debt to Equity History January 10th 2021

How Strong Is Amneal Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Amneal Pharmaceuticals had liabilities of US$667.9m falling due within a year, and liabilities of US$3.01b due beyond that. On the other hand, it had cash of US$282.0m and US$743.3m worth of receivables due within a year. So its liabilities total US$2.65b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$1.43b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Amneal Pharmaceuticals would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.99 times and a disturbingly high net debt to EBITDA ratio of 6.9 hit our confidence in Amneal Pharmaceuticals like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Amneal Pharmaceuticals actually grew its EBIT by a hefty 189%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. 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 Amneal Pharmaceuticals 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Amneal Pharmaceuticals recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both Amneal Pharmaceuticals's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Amneal Pharmaceuticals's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Amneal Pharmaceuticals has 2 warning signs (and 1 which can't be ignored) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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