Johns Lyng Group (ASX:JLG) Has A Rock Solid Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Johns Lyng Group Limited (ASX:JLG) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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.

See our latest analysis for Johns Lyng Group

What Is Johns Lyng Group's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Johns Lyng Group had debt of AU$16.6m, up from AU$4.29m in one year. But on the other hand it also has AU$53.2m in cash, leading to a AU$36.7m net cash position.

How Healthy Is Johns Lyng Group's Balance Sheet?

We can see from the most recent balance sheet that Johns Lyng Group had liabilities of AU$125.3m falling due within a year, and liabilities of AU$28.6m due beyond that. On the other hand, it had cash of AU$53.2m and AU$82.8m worth of receivables due within a year. So its liabilities total AU$17.9m more than the combination of its cash and short-term receivables.

Since publicly traded Johns Lyng Group shares are worth a total of AU$811.0m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Johns Lyng Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Johns Lyng Group grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. 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 Johns Lyng Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Johns Lyng Group 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 last three years, Johns Lyng Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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$36.7m. And it impressed us with free cash flow of AU$62m, being 118% of its EBIT. So we don't think Johns Lyng Group's use of debt is risky. Another factor that would give us confidence in Johns Lyng Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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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