Is Lexicon Pharmaceuticals (NASDAQ:LXRX) A Risky Investment?

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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Lexicon Pharmaceuticals, Inc. (NASDAQ:LXRX) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Lexicon Pharmaceuticals

What Is Lexicon Pharmaceuticals's Net Debt?

The chart below, which you can click on for greater detail, shows that Lexicon Pharmaceuticals had US$245.1m in debt in September 2019; about the same as the year before. However, it does have US$296.3m in cash offsetting this, leading to net cash of US$51.2m.

How Healthy Is Lexicon Pharmaceuticals's Balance Sheet?

The latest balance sheet data shows that Lexicon Pharmaceuticals had liabilities of US$44.8m due within a year, and liabilities of US$235.1m falling due after that. Offsetting this, it had US$296.3m in cash and US$56.8m in receivables that were due within 12 months. So it can boast US$73.3m more liquid assets than total liabilities.

This excess liquidity suggests that Lexicon Pharmaceuticals is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Lexicon Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Lexicon Pharmaceuticals made a loss at the EBIT level, last year, it was also good to see that it generated US$205m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Lexicon 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. Lexicon 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 most recent year, Lexicon Pharmaceuticals recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Lexicon Pharmaceuticals has US$51.2m in net cash and a decent-looking balance sheet. So we don't think Lexicon Pharmaceuticals's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Lexicon Pharmaceuticals insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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