Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Amphastar Pharmaceuticals, Inc. (NASDAQ:AMPH) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Amphastar Pharmaceuticals's Debt?
As you can see below, at the end of June 2022, Amphastar Pharmaceuticals had US$75.7m of debt, up from US$38.1m a year ago. Click the image for more detail. But on the other hand it also has US$183.4m in cash, leading to a US$107.7m net cash position.
A Look At Amphastar Pharmaceuticals' Liabilities
We can see from the most recent balance sheet that Amphastar Pharmaceuticals had liabilities of US$103.6m falling due within a year, and liabilities of US$120.8m due beyond that. On the other hand, it had cash of US$183.4m and US$86.7m worth of receivables due within a year. So it can boast US$45.7m more liquid assets than total liabilities.
This surplus suggests that Amphastar Pharmaceuticals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Amphastar Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Amphastar Pharmaceuticals grew its EBIT by 229% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Amphastar Pharmaceuticals'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. Amphastar Pharmaceuticals may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Amphastar Pharmaceuticals recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While it is always sensible to investigate a company's debt, in this case Amphastar Pharmaceuticals has US$107.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$70m, being 84% of its EBIT. So is Amphastar Pharmaceuticals's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Amphastar Pharmaceuticals you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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