Here’s why Hikma Pharmaceuticals (LON:HIK) can manage its debt responsibly

Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Hikma Pharmaceuticals PLC (LON:HIK) has debt on its balance sheet. But does this debt worry shareholders?

What risk does debt carry?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Hikma Pharmaceuticals

What is Hikma Pharmaceuticals’ net debt?

As you can see below, Hikma Pharmaceuticals had a debt of US$763.0 million in December 2021, compared to US$850.0 million the previous year. However, he has $426.0 million in cash to offset this, resulting in a net debt of approximately $337.0 million.

LSE:HIK Debt to Equity February 26, 2022

How strong is Hikma Pharmaceuticals’ balance sheet?

We can see from the most recent balance sheet that Hikma Pharmaceuticals had liabilities of US$1.02 billion due within one year, and liabilities of US$889.0 million beyond that. On the other hand, it had a cash position of 426.0 million dollars and 876.0 million dollars of receivables at less than one year. It therefore has liabilities totaling $603.0 million more than its cash and short-term receivables, combined.

Given that Hikma Pharmaceuticals has a market capitalization of US$6.04 billion, it’s hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Hikma Pharmaceuticals has net debt of just 0.47 times EBITDA, indicating that it is certainly not an imprudent borrower. And this view is supported by strong interest coverage, with EBIT amounting to 8.4 times interest expense over the past year. While Hikma Pharmaceuticals doesn’t appear to have gained much on the EBIT line, at least earnings are holding steady for now. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Hikma Pharmaceuticals can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Hikma Pharmaceuticals has recorded free cash flow of 57% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

Fortunately, Hikma Pharmaceuticals’ impressive net debt to EBITDA ratio means it has the upper hand on its debt. And we also thought its interest coverage was a positive. All told, it looks like Hikma Pharmaceuticals can comfortably manage its current level of debt. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. Over time, stock prices tend to follow earnings per share, so if you’re interested in Hikma Pharmaceuticals, you might want to click here to view an interactive chart of its earnings per share history.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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John A. Bogar