Yahoo Finance Alliance Pharma (LON:APH) Has A Pretty Healthy Balance Sheet
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. 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 Alliance Pharma plc (LON:APH) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 Alliance Pharma
What Is Alliance Pharma's Debt?
You can click the graphic below for the historical numbers, but it shows that Alliance Pharma had UK£90.6m of debt in June 2019, down from UK£100.8m, one year before. On the flip side, it has UK£16.5m in cash leading to net debt of about UK£74.2m.
How Healthy Is Alliance Pharma's Balance Sheet?
The latest balance sheet data shows that Alliance Pharma had liabilities of UK£94.2m due within a year, and liabilities of UK£55.2m falling due after that. On the other hand, it had cash of UK£16.5m and UK£23.2m worth of receivables due within a year. So it has liabilities totalling UK£109.7m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Alliance Pharma has a market capitalization of UK£380.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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.
Alliance Pharma's net debt of 2.1 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.6 times interest expense) certainly does not do anything to dispel this impression. Also relevant is that Alliance Pharma has grown its EBIT by a very respectable 26% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alliance Pharma can strengthen its balance sheet over time. 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Alliance Pharma generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Our View
The good news is that Alliance Pharma's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Alliance Pharma's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Alliance Pharma insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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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. Thank you for reading.
