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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Jet2 plc (LON:JET2) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Jet2
What Is Jet2's Debt?
The image below, which you can click on for greater detail, shows that Jet2 had debt of UK£729.2m at the end of March 2023, a reduction from UK£991.7m over a year. However, it does have UK£2.62b in cash offsetting this, leading to net cash of UK£1.90b.
How Strong Is Jet2's Balance Sheet?
According to the last reported balance sheet, Jet2 had liabilities of UK£2.26b due within 12 months, and liabilities of UK£1.26b due beyond 12 months. Offsetting these obligations, it had cash of UK£2.62b as well as receivables valued at UK£281.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£607.7m.
While this might seem like a lot, it is not so bad since Jet2 has a market capitalization of UK£2.43b, 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. Despite its noteworthy liabilities, Jet2 boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Jet2 made a loss at the EBIT level, last year, it was also good to see that it generated UK£394m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Jet2'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Jet2 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, Jet2 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.
Summing Up
Although Jet2's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£1.90b. The cherry on top was that in converted 192% of that EBIT to free cash flow, bringing in UK£758m. So we don't think Jet2's use of debt is risky. We'd be motivated to research the stock further if we found out that Jet2 insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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. 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.
About AIM:JET2
Jet2
Engages in the leisure travel business primarily in the United Kingdom.
Very undervalued with flawless balance sheet.