We Think JB Hi-Fi (ASX:JBH) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 JB Hi-Fi Limited (ASX:JBH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for JB Hi-Fi

How Much Debt Does JB Hi-Fi Carry?

The image below, which you can click on for greater detail, shows that JB Hi-Fi had debt of AU$49.8m at the end of June 2023, a reduction from AU$59.4m over a year. But it also has AU$177.3m in cash to offset that, meaning it has AU$127.5m net cash.

A Look At JB Hi-Fi's Liabilities

We can see from the most recent balance sheet that JB Hi-Fi had liabilities of AU$1.18b falling due within a year, and liabilities of AU$630.4m due beyond that. Offsetting this, it had AU$177.3m in cash and AU$146.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.49b.

This deficit isn't so bad because JB Hi-Fi is worth AU$4.97b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, JB Hi-Fi boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that JB Hi-Fi saw its EBIT decline by 3.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 JB Hi-Fi's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. JB Hi-Fi 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 most recent three years, JB Hi-Fi recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While JB Hi-Fi does have more liabilities than liquid assets, it also has net cash of AU$127.5m. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in AU$644m. So we don't have any problem with JB Hi-Fi's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example JB Hi-Fi has 3 warning signs (and 1 which is significant) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.