Is Johns Lyng Group (ASX:JLG) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Johns Lyng Group Limited (ASX:JLG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Johns Lyng Group

What Is Johns Lyng Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Johns Lyng Group had AU$11.2m of debt in June 2021, down from AU$16.9m, one year before. But it also has AU$43.3m in cash to offset that, meaning it has AU$32.1m net cash.

How Strong Is Johns Lyng Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Johns Lyng Group had liabilities of AU$147.7m due within 12 months and liabilities of AU$27.2m due beyond that. Offsetting these obligations, it had cash of AU$43.3m as well as receivables valued at AU$119.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$12.1m.

Having regard to Johns Lyng Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$1.51b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Johns Lyng Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Johns Lyng Group has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. 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 Johns Lyng Group 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. While Johns Lyng Group 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 last three years, Johns Lyng Group recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Johns Lyng Group's liabilities, but we can be reassured by the fact it has has net cash of AU$32.1m. And it impressed us with free cash flow of AU$26m, being 99% of its EBIT. So we don't think Johns Lyng Group's use of debt is risky. 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. For instance, we've identified 1 warning sign for Johns Lyng Group 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.

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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