Here's Why Ligand Pharmaceuticals (NASDAQ:LGND) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Ligand Pharmaceuticals

What Is Ligand Pharmaceuticals's Net Debt?

As you can see below, Ligand Pharmaceuticals had US$176.5m of debt at March 2022, down from US$352.3m a year prior. However, it does have US$204.0m in cash offsetting this, leading to net cash of US$27.5m.

How Strong Is Ligand Pharmaceuticals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ligand Pharmaceuticals had liabilities of US$42.6m due within 12 months and liabilities of US$269.4m due beyond that. Offsetting this, it had US$204.0m in cash and US$41.8m in receivables that were due within 12 months. So it has liabilities totalling US$66.2m more than its cash and near-term receivables, combined.

Given Ligand Pharmaceuticals has a market capitalization of US$1.51b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Ligand Pharmaceuticals also has more cash than debt, so we're pretty confident it can manage its debt safely.

Unfortunately, Ligand Pharmaceuticals's EBIT flopped 10% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ligand Pharmaceuticals can strengthen its balance sheet over time. 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. While Ligand Pharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Ligand Pharmaceuticals actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Ligand Pharmaceuticals's liabilities, but we can be reassured by the fact it has has net cash of US$27.5m. And it impressed us with free cash flow of US$110m, being 264% of its EBIT. So we are not troubled with Ligand Pharmaceuticals's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Ligand Pharmaceuticals is showing 4 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.