Is Jatcorp (ASX:JAT) Using Too Much Debt?

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. As with many other companies Jatcorp Limited (ASX:JAT) makes use of 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. 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, 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.

See our latest analysis for Jatcorp

What Is Jatcorp's Debt?

As you can see below, Jatcorp had AU$7.83m of debt at June 2021, down from AU$19.9m a year prior. However, it also had AU$6.41m in cash, and so its net debt is AU$1.42m.

How Healthy Is Jatcorp's Balance Sheet?

We can see from the most recent balance sheet that Jatcorp had liabilities of AU$13.0m falling due within a year, and liabilities of AU$5.58m due beyond that. Offsetting these obligations, it had cash of AU$6.41m as well as receivables valued at AU$454.5k due within 12 months. So its liabilities total AU$11.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Jatcorp has a market capitalization of AU$29.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jatcorp will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Jatcorp had a loss before interest and tax, and actually shrunk its revenue by 65%, to AU$21m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Jatcorp's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable AU$5.8m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$3.7m of cash over the last year. So in short it's a really risky stock. 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. We've identified 4 warning signs with Jatcorp (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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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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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