Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Lannett Company, Inc. (NYSE: LCI) uses debt in its business. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Lannett Company
What is Lannett’s net debt?
You can click on the graph below for historical figures, but it shows that Lannett Company was in debt of $ 610.7 million in March 2021, up from $ 694.6 million a year earlier. However, given that it has a cash reserve of $ 81.3 million, its net debt is less, at around $ 529.4 million.
A look at the responsibilities of Lannett Company
According to the latest published balance sheet, Lannett Company had a liability of US $ 97.1 million due within 12 months and a liability of US $ 641.2 million due beyond 12 months. In compensation for these obligations, he had cash of US $ 81.3 million as well as receivables valued at US $ 154.7 million at 12 months. It therefore has a liability totaling US $ 502.3 million more than its cash and short-term receivables combined.
This deficit casts a shadow over the $ 187.7 million company, like a colossus towering over mere mortals. So we would be watching its record closely, without a doubt. Ultimately, Lannett Company would likely need a major recapitalization if its creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Lannett Company shareholders face the double whammy of a high net debt to EBITDA ratio (9.5) and relatively low interest coverage, as EBIT is only 0.047 times interest expense. The debt burden here is considerable. Worse yet, Lannett Company has seen its EBIT reach 96% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Lannett Company’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 analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Lannett Company has actually generated more free cash flow than EBIT over the past three years. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
At first glance, Lannett Company’s EBIT growth rate left us hesitant about the stock, and its total liability level was no more attractive than the single empty restaurant on the busiest night of the year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Considering all of the above factors, it looks like the Lannett company has too much debt. While some investors like this kind of risky game, it is certainly not our cup of tea. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 3 warning signs we spotted with Lannett Company.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
If you are looking to trade the Lannett company, open an account with the cheapest * professionally approved platform, Interactive brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.