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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that JNBY Design Limited (HKG:3306) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is JNBY Design's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 JNBY Design had CN¥90.0m of debt, an increase on none, over one year. However, it does have CN¥906.5m in cash offsetting this, leading to net cash of CN¥816.5m.
How Healthy Is JNBY Design's Balance Sheet?
The latest balance sheet data shows that JNBY Design had liabilities of CN¥1.34b due within a year, and liabilities of CN¥108.4m falling due after that. On the other hand, it had cash of CN¥906.5m and CN¥233.2m worth of receivables due within a year. So its liabilities total CN¥307.0m more than the combination of its cash and short-term receivables.
Given JNBY Design has a market capitalization of CN¥3.73b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, JNBY Design boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that JNBY Design has increased its EBIT by 8.0% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if JNBY Design 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While JNBY Design 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 three years, JNBY Design recorded free cash flow worth 53% 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that JNBY Design has CN¥816.5m in net cash. On top of that, it increased its EBIT by 8.0% in the last twelve months. So we are not troubled with JNBY Design's debt use. 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 instance, we've identified 2 warning signs for JNBY Design that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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