Stock Analysis

Aspen Pharmacare Holdings (JSE:APN) Seems To Use Debt Quite Sensibly

JSE:APN
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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.' 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 can see that Aspen Pharmacare Holdings Limited (JSE:APN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. 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.

See our latest analysis for Aspen Pharmacare Holdings

How Much Debt Does Aspen Pharmacare Holdings Carry?

The image below, which you can click on for greater detail, shows that Aspen Pharmacare Holdings had debt of R7.27b at the end of December 2021, a reduction from R37.5b over a year. However, it does have R7.88b in cash offsetting this, leading to net cash of R602.0m.

debt-equity-history-analysis
JSE:APN Debt to Equity History April 2nd 2022

How Strong Is Aspen Pharmacare Holdings' Balance Sheet?

According to the last reported balance sheet, Aspen Pharmacare Holdings had liabilities of R18.6b due within 12 months, and liabilities of R26.8b due beyond 12 months. Offsetting this, it had R7.88b in cash and R12.8b in receivables that were due within 12 months. So its liabilities total R24.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Aspen Pharmacare Holdings has a market capitalization of R91.3b, 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. While it does have liabilities worth noting, Aspen Pharmacare Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Aspen Pharmacare Holdings grew its EBIT by 10% last year, making its debt load easier to handle. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Aspen Pharmacare Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Aspen Pharmacare Holdings recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Aspen Pharmacare Holdings does have more liabilities than liquid assets, it also has net cash of R602.0m. On top of that, it increased its EBIT by 10% in the last twelve months. So we don't have any problem with Aspen Pharmacare Holdings's use of debt. 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.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Aspen Pharmacare Holdings is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.