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.' 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. As with many other companies Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?
As you can see below, Ligand Pharmaceuticals had US$320.7m of debt at December 2021, down from US$442.3m a year prior. But it also has US$341.1m in cash to offset that, meaning it has US$20.4m 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$41.7m due within 12 months and liabilities of US$434.8m due beyond that. On the other hand, it had cash of US$341.1m and US$91.6m worth of receivables due within a year. So it has liabilities totalling US$43.7m more than its cash and near-term receivables, combined.
Since publicly traded Ligand Pharmaceuticals shares are worth a total of US$1.83b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Ligand Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, Ligand Pharmaceuticals grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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. 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. 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Ligand Pharmaceuticals has US$20.4m in net cash. The cherry on top was that in converted 173% of that EBIT to free cash flow, bringing in US$71m. So is Ligand Pharmaceuticals's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 3 warning signs for Ligand Pharmaceuticals you should be aware of, and 1 of them is a bit unpleasant.
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.
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.