These 4 Measures Indicate That Aspen Pharmacare Holdings (JSE:APN) Is Using Debt Reasonably Well

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 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. As with many other companies Aspen Pharmacare Holdings Limited (JSE:APN) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Our analysis indicates that APN is potentially undervalued!

What Is Aspen Pharmacare Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Aspen Pharmacare Holdings had R21.9b of debt in June 2022, down from R24.5b, one year before. However, it does have R6.18b in cash offsetting this, leading to net debt of about R15.7b.

A Look At Aspen Pharmacare Holdings' Liabilities

We can see from the most recent balance sheet that Aspen Pharmacare Holdings had liabilities of R23.4b falling due within a year, and liabilities of R17.0b due beyond that. Offsetting these obligations, it had cash of R6.18b as well as receivables valued at R12.3b due within 12 months. So it has liabilities totalling R22.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Aspen Pharmacare Holdings is worth R66.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Aspen Pharmacare Holdings's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 12.2 times its interest expense, implies the debt load is as light as a peacock feather. The good news is that Aspen Pharmacare Holdings has increased its EBIT by 8.8% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Aspen Pharmacare Holdings recorded free cash flow worth 50% 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

Aspen Pharmacare Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And its EBIT growth rate is good too. All these things considered, it appears that Aspen Pharmacare Holdings can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. We'd be motivated to research the stock further if we found out that Aspen Pharmacare Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.