Is Johnson Electric Holdings (HKG:179) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Johnson Electric Holdings Limited (HKG:179) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Johnson Electric Holdings

How Much Debt Does Johnson Electric Holdings Carry?

The image below, which you can click on for greater detail, shows that Johnson Electric Holdings had debt of US$368.3m at the end of September 2023, a reduction from US$471.7m over a year. However, its balance sheet shows it holds US$461.3m in cash, so it actually has US$93.1m net cash.

A Look At Johnson Electric Holdings' Liabilities

The latest balance sheet data shows that Johnson Electric Holdings had liabilities of US$1.21b due within a year, and liabilities of US$293.0m falling due after that. Offsetting this, it had US$461.3m in cash and US$689.8m in receivables that were due within 12 months. So it has liabilities totalling US$350.7m more than its cash and near-term receivables, combined.

Johnson Electric Holdings has a market capitalization of US$1.41b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Johnson Electric Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Johnson Electric Holdings grew its EBIT by 329% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Johnson Electric Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Johnson Electric Holdings 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, Johnson Electric Holdings recorded free cash flow worth 63% 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

Although Johnson Electric Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$93.1m. And we liked the look of last year's 329% year-on-year EBIT growth. So we don't think Johnson Electric Holdings's use of debt is risky. 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. Be aware that Johnson Electric Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.