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 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 can see that Pacira BioSciences, Inc. (NASDAQ:PCRX) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Pacira BioSciences's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Pacira BioSciences had US$298.2m of debt, an increase on US$283.6m, over one year. On the flip side, it has US$292.2m in cash leading to net debt of about US$5.95m.
How Healthy Is Pacira BioSciences's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Pacira BioSciences had liabilities of US$83.0m due within 12 months and liabilities of US$363.2m due beyond that. Offsetting these obligations, it had cash of US$292.2m as well as receivables valued at US$41.1m due within 12 months. So it has liabilities totalling US$112.8m more than its cash and near-term receivables, combined.
Given Pacira BioSciences has a market capitalization of US$1.52b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Pacira BioSciences has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Given net debt is only 0.14 times EBITDA, it is initially surprising to see that Pacira BioSciences's EBIT has low interest coverage of 1.8 times. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Pacira BioSciences is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 450% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Pacira BioSciences'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Pacira BioSciences actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Happily, Pacira BioSciences's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But the stark truth is that we are concerned by its interest cover. Looking at the bigger picture, we think Pacira BioSciences's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. We'd be motivated to research the stock further if we found out that Pacira BioSciences 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, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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