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Is Lexicon Pharmaceuticals (NASDAQ:LXRX) Using Too Much Debt?

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Lexicon Pharmaceuticals, Inc. (NASDAQ:LXRX) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Lexicon Pharmaceuticals

What Is Lexicon Pharmaceuticals's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2019 Lexicon Pharmaceuticals had debt of US$245.1m, up from US$245 in one year. But on the other hand it also has US$296.3m in cash, leading to a US$51.2m net cash position.

NasdaqGS:LXRX Historical Debt, January 20th 2020
NasdaqGS:LXRX Historical Debt, January 20th 2020

A Look At Lexicon Pharmaceuticals's Liabilities

The latest balance sheet data shows that Lexicon Pharmaceuticals had liabilities of US$44.8m due within a year, and liabilities of US$235.1m falling due after that. Offsetting this, it had US$296.3m in cash and US$56.8m in receivables that were due within 12 months. So it actually has US$73.3m more liquid assets than total liabilities.

This surplus suggests that Lexicon Pharmaceuticals is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Lexicon Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Lexicon Pharmaceuticals turned things around in the last 12 months, delivering and EBIT of US$205m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lexicon 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lexicon 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 most recent year, Lexicon Pharmaceuticals recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Lexicon Pharmaceuticals has US$51.2m in net cash and a decent-looking balance sheet. So we don't think Lexicon Pharmaceuticals's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Lexicon Pharmaceuticals (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.