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.' 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. We note that Halozyme Therapeutics, Inc. (NASDAQ:HALO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Halozyme Therapeutics's Debt?

As you can see below, Halozyme Therapeutics had US$1.50b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$666.3m in cash, and so its net debt is US$837.8m.

How Strong Is Halozyme Therapeutics' Balance Sheet?

We can see from the most recent balance sheet that Halozyme Therapeutics had liabilities of US$108.8m falling due within a year, and liabilities of US$1.56b due beyond that. Offsetting these obligations, it had cash of US$666.3m as well as receivables valued at US$285.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$713.3m.

Of course, Halozyme Therapeutics has a market capitalization of US$6.08b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Halozyme Therapeutics's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 60.1 times its interest expense, implies the debt load is as light as a peacock feather. On top of that, Halozyme Therapeutics grew its EBIT by 42% 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 ultimately the future profitability of the business will decide if Halozyme Therapeutics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Halozyme Therapeutics generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Halozyme Therapeutics's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Halozyme Therapeutics is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. For example - Halozyme Therapeutics has 1 warning sign we think you should be aware of.

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.

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.