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. Importantly, Johnson Electric Holdings Limited (HKG:179) 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. 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.
Check out our latest analysis for Johnson Electric Holdings
What Is Johnson Electric Holdings's Net Debt?
As you can see below, Johnson Electric Holdings had US$368.3m of debt at September 2023, down from US$471.7m a year prior. But it also has US$461.3m in cash to offset that, meaning it has US$93.1m net cash.
How Strong Is Johnson Electric Holdings' Balance Sheet?
According to the last reported balance sheet, Johnson Electric Holdings had liabilities of US$1.21b due within 12 months, and liabilities of US$293.0m due beyond 12 months. Offsetting this, it had US$461.3m in cash and US$689.8m in receivables that were due within 12 months. So its liabilities total US$350.7m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Johnson Electric Holdings has a market capitalization of US$1.39b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Johnson Electric Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Johnson Electric Holdings grew its EBIT by 329% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Johnson Electric Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Johnson Electric Holdings 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 most recent three years, Johnson Electric Holdings recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While Johnson Electric Holdings does have more liabilities than liquid assets, it also has net cash of US$93.1m. And it impressed us with its EBIT growth of 329% over the last year. So is Johnson Electric Holdings's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Johnson Electric Holdings you should be aware of.
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.
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