Aspen Pharmacare Holdings (JSE:APN) Has A Pretty Healthy Balance Sheet

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.' 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. Importantly, Aspen Pharmacare Holdings Limited (JSE:APN) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Aspen Pharmacare Holdings

What Is Aspen Pharmacare Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Aspen Pharmacare Holdings had R28.8b of debt, an increase on R21.9b, over one year. However, it does have R10.9b in cash offsetting this, leading to net debt of about R17.9b.

How Healthy Is Aspen Pharmacare Holdings' Balance Sheet?

We can see from the most recent balance sheet that Aspen Pharmacare Holdings had liabilities of R23.1b falling due within a year, and liabilities of R24.9b due beyond that. Offsetting these obligations, it had cash of R10.9b as well as receivables valued at R13.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R23.5b.

While this might seem like a lot, it is not so bad since Aspen Pharmacare Holdings has a market capitalization of R85.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Aspen Pharmacare Holdings's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its commanding EBIT of 10.7 times its interest expense, implies the debt load is as light as a peacock feather. We saw Aspen Pharmacare Holdings grow its EBIT by 2.2% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aspen Pharmacare Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Aspen Pharmacare Holdings's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Aspen Pharmacare Holdings's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Aspen Pharmacare Holdings's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Aspen Pharmacare Holdings's earnings per share history for free.

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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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.