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. We note that Pacira BioSciences, Inc. (NASDAQ:PCRX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Pacira BioSciences's Debt?
The image below, which you can click on for greater detail, shows that Pacira BioSciences had debt of US$522.4m at the end of December 2023, a reduction from US$689.5m over a year. However, it does have US$278.6m in cash offsetting this, leading to net debt of about US$243.9m.
How Strong Is Pacira BioSciences' Balance Sheet?
The latest balance sheet data shows that Pacira BioSciences had liabilities of US$97.4m due within a year, and liabilities of US$606.9m falling due after that. Offsetting these obligations, it had cash of US$278.6m as well as receivables valued at US$106.0m due within 12 months. So its liabilities total US$319.7m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Pacira BioSciences has a market capitalization of US$1.33b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
With net debt sitting at just 1.5 times EBITDA, Pacira BioSciences is arguably pretty conservatively geared. And it boasts interest cover of 9.9 times, which is more than adequate. Another good sign is that Pacira BioSciences has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pacira BioSciences can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Pacira BioSciences actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
The good news is that Pacira BioSciences's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Pacira BioSciences seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Pacira BioSciences , and understanding them should be part of your investment process.
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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