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.' 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. We can see that ANI Pharmaceuticals, Inc. (NASDAQ:ANIP) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does ANI Pharmaceuticals Carry?
You can click the graphic below for the historical numbers, but it shows that ANI Pharmaceuticals had US$192.1m of debt in June 2019, down from US$204.6m, one year before. However, because it has a cash reserve of US$40.6m, its net debt is less, at about US$151.5m.
How Strong Is ANI Pharmaceuticals's Balance Sheet?
We can see from the most recent balance sheet that ANI Pharmaceuticals had liabilities of US$166.8m falling due within a year, and liabilities of US$72.5m due beyond that. On the other hand, it had cash of US$40.6m and US$76.3m worth of receivables due within a year. So its liabilities total US$122.4m more than the combination of its cash and short-term receivables.
Of course, ANI Pharmaceuticals has a market capitalization of US$840.8m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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.
ANI Pharmaceuticals's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 3.1 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We saw ANI Pharmaceuticals grow its EBIT by 4.9% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 ANI Pharmaceuticals'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, ANI Pharmaceuticals recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
ANI Pharmaceuticals's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its level of total liabilities is relatively strong. Taking the abovementioned factors together we do think ANI Pharmaceuticals's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Given our hesitation about the stock, it would be good to know if ANI Pharmaceuticals insiders have sold any shares recently. You click here to find out if insiders have sold recently.
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.
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