Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that JB Hi-Fi Limited (ASX:JBH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is JB Hi-Fi's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2022 JB Hi-Fi had debt of AU$59.4m, up from none in one year. But it also has AU$125.6m in cash to offset that, meaning it has AU$66.2m net cash.
How Healthy Is JB Hi-Fi's Balance Sheet?
According to the last reported balance sheet, JB Hi-Fi had liabilities of AU$1.31b due within 12 months, and liabilities of AU$574.8m due beyond 12 months. Offsetting these obligations, it had cash of AU$125.6m as well as receivables valued at AU$132.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.62b.
This deficit isn't so bad because JB Hi-Fi is worth AU$4.83b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, JB Hi-Fi boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, JB Hi-Fi grew its EBIT by 6.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if JB Hi-Fi can strengthen its balance sheet over time. 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. JB Hi-Fi 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. During the last three years, JB Hi-Fi generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While JB Hi-Fi does have more liabilities than liquid assets, it also has net cash of AU$66.2m. And it impressed us with free cash flow of AU$570m, being 99% of its EBIT. So we don't think JB Hi-Fi'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. Case in point: We've spotted 2 warning signs for JB Hi-Fi you should be aware of, and 1 of them is potentially serious.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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