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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its 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$315.3m of debt in June 2021, down from US$449.7m, one year before. However, it does have US$301.8m in cash offsetting this, leading to net debt of about US$13.5m.
How Strong Is Ligand Pharmaceuticals' Balance Sheet?
According to the last reported balance sheet, Ligand Pharmaceuticals had liabilities of US$52.5m due within 12 months, and liabilities of US$417.3m due beyond 12 months. On the other hand, it had cash of US$301.8m and US$62.9m worth of receivables due within a year. So it has liabilities totalling US$105.1m more than its cash and near-term receivables, combined.
Since publicly traded Ligand Pharmaceuticals shares are worth a total of US$1.76b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Ligand Pharmaceuticals has virtually no net debt, so it's fair to say it does not have a heavy debt load!
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Given net debt is only 0.17 times EBITDA, it is initially surprising to see that Ligand Pharmaceuticals's EBIT has low interest coverage of 1.6 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Ligand Pharmaceuticals improved its EBIT from a last year's loss to a positive US$35m. 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 Ligand Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Ligand Pharmaceuticals actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
The good news is that Ligand Pharmaceuticals's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. When we consider the range of factors above, it looks like Ligand Pharmaceuticals is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 5 warning signs for Ligand Pharmaceuticals (2 are potentially serious!) that you should be aware of before investing here.
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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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.