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. Importantly, Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) does carry debt. But should shareholders be worried about its use of debt?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ligand Pharmaceuticals's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Ligand Pharmaceuticals had US$455.0m of debt in September 2020, down from US$631.5m, one year before. But it also has US$795.1m in cash to offset that, meaning it has US$340.1m net cash.
A Look At Ligand Pharmaceuticals' Liabilities
Zooming in on the latest balance sheet data, we can see that Ligand Pharmaceuticals had liabilities of US$42.3m due within 12 months and liabilities of US$507.3m due beyond that. Offsetting these obligations, it had cash of US$795.1m as well as receivables valued at US$32.9m due within 12 months. So it can boast US$278.4m more liquid assets than total liabilities.
It's good to see that Ligand Pharmaceuticals has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Ligand Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.
Importantly, Ligand Pharmaceuticals's EBIT fell a jaw-dropping 81% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ligand Pharmaceuticals 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ligand 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. Happily for any shareholders, Ligand Pharmaceuticals actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Ligand Pharmaceuticals has net cash of US$340.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$44m, being 518% 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 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
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.
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What are the risks and opportunities for Ligand Pharmaceuticals?
Trading at 55.9% below our estimate of its fair value
Earnings are forecast to grow 120.84% per year
Significant insider selling over the past 3 months
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Ligand Pharmaceuticals Incorporated, a biopharmaceutical company, focuses on developing or acquiring technologies that help pharmaceutical companies to discover and develop medicines worldwide.
Excellent balance sheet and fair value.