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Is Pharming Group (AMS:PHARM) A Risky Investment?

Simply Wall St

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Pharming Group N.V. (AMS:PHARM) does carry debt. But should shareholders be worried about its use of debt?

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 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Pharming Group

What Is Pharming Group's Net Debt?

The image below, which you can click on for greater detail, shows that Pharming Group had debt of €54.1m at the end of September 2019, a reduction from €77.8m over a year. However, it does have €63.0m in cash offsetting this, leading to net cash of €8.88m.

ENXTAM:PHARM Historical Debt, December 14th 2019

How Strong Is Pharming Group's Balance Sheet?

We can see from the most recent balance sheet that Pharming Group had liabilities of €90.1m falling due within a year, and liabilities of €40.2m due beyond that. On the other hand, it had cash of €63.0m and €27.0m worth of receivables due within a year. So its liabilities total €40.4m more than the combination of its cash and short-term receivables.

Since publicly traded Pharming Group shares are worth a total of €974.6m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Pharming Group boasts net cash, so it's fair to say it does not have a heavy debt load!

We note that Pharming Group grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pharming Group'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. While Pharming Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Pharming Group generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Pharming Group's liabilities, but we can be reassured by the fact it has has net cash of €8.88m. And it impressed us with free cash flow of €41m, being 97% of its EBIT. So we don't think Pharming Group's use of debt is risky. Another factor that would give us confidence in Pharming Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.