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.’ 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 J.B. Hunt Transport Services, Inc. (NASDAQ:JBHT) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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.
What Is J.B. Hunt Transport Services’s Debt?
You can click the graphic below for the historical numbers, but it shows that J.B. Hunt Transport Services had US$1.31b of debt in June 2020, down from US$1.37b, one year before. However, because it has a cash reserve of US$274.7m, its net debt is less, at about US$1.03b.
A Look At J.B. Hunt Transport Services’s Liabilities
The latest balance sheet data shows that J.B. Hunt Transport Services had liabilities of US$970.7m due within a year, and liabilities of US$2.19b falling due after that. On the other hand, it had cash of US$274.7m and US$950.6m worth of receivables due within a year. So it has liabilities totalling US$1.9b more than its cash and near-term receivables, combined.
Given J.B. Hunt Transport Services has a humongous market capitalization of US$15.0b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
J.B. Hunt Transport Services has a low net debt to EBITDA ratio of only 0.84. And its EBIT easily covers its interest expense, being 14.4 times the size. So we’re pretty relaxed about its super-conservative use of debt. The good news is that J.B. Hunt Transport Services has increased its EBIT by 5.9% 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 J.B. Hunt Transport Services 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, J.B. Hunt Transport Services’s free cash flow amounted to 33% of its EBIT, less than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
The good news is that J.B. Hunt Transport Services’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that J.B. Hunt Transport Services can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 2 warning signs for J.B. Hunt Transport Services 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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