We Think Ligand Pharmaceuticals (NASDAQ:LGND) Can Stay On Top Of Its Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out the opportunities and risks within the US Biotechs industry.

What Is Ligand Pharmaceuticals's Net Debt?

The image below, which you can click on for greater detail, shows that Ligand Pharmaceuticals had debt of US$115.0m at the end of June 2022, a reduction from US$315.3m over a year. However, its balance sheet shows it holds US$147.9m in cash, so it actually has US$33.0m net cash.

How Strong Is Ligand Pharmaceuticals' Balance Sheet?

According to the last reported balance sheet, Ligand Pharmaceuticals had liabilities of US$167.9m due within 12 months, and liabilities of US$106.1m due beyond 12 months. On the other hand, it had cash of US$147.9m and US$63.3m worth of receivables due within a year. So its liabilities total US$62.7m more than the combination of its cash and short-term receivables.

Of course, Ligand Pharmaceuticals has a market capitalization of US$1.45b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

Shareholders should be aware that Ligand Pharmaceuticals's EBIT was down 57% last year. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ligand Pharmaceuticals has US$33.0m in net cash. The cherry on top was that in converted 268% of that EBIT to free cash flow, bringing in US$97m. So we don't have any problem with Ligand Pharmaceuticals's use of debt. 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. To that end, you should learn about the 2 warning signs we've spotted with Ligand Pharmaceuticals (including 1 which is a bit concerning) .

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.