Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 John Lewis of Hungerford plc (LON:JLH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is John Lewis of Hungerford's Debt?
The image below, which you can click on for greater detail, shows that John Lewis of Hungerford had debt of UK£1.14m at the end of June 2021, a reduction from UK£1.19m over a year. But on the other hand it also has UK£1.30m in cash, leading to a UK£164.5k net cash position.
How Healthy Is John Lewis of Hungerford's Balance Sheet?
The latest balance sheet data shows that John Lewis of Hungerford had liabilities of UK£3.29m due within a year, and liabilities of UK£2.53m falling due after that. Offsetting these obligations, it had cash of UK£1.30m as well as receivables valued at UK£868.9k due within 12 months. So its liabilities total UK£3.65m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of UK£2.81m, we think shareholders really should watch John Lewis of Hungerford's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. John Lewis of Hungerford boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
We also note that John Lewis of Hungerford improved its EBIT from a last year's loss to a positive UK£307k. The balance sheet is clearly the area to focus on when you are analysing debt. But it is John Lewis of Hungerford's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. John Lewis of Hungerford 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 year, John Lewis of Hungerford actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While John Lewis of Hungerford does have more liabilities than liquid assets, it also has net cash of UK£164.5k. The cherry on top was that in converted 429% of that EBIT to free cash flow, bringing in UK£1.3m. So although we see some areas for improvement, we're not too worried about John Lewis of Hungerford's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for John Lewis of Hungerford (2 don't sit too well with us!) that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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