Here's Why JNBY Design (HKG:3306) Can Manage Its Debt Responsibly

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.' 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. Importantly, JNBY Design Limited (HKG:3306) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for JNBY Design

How Much Debt Does JNBY Design Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 JNBY Design had CN¥193.0m of debt, an increase on CN¥90.0m, over one year. But on the other hand it also has CN¥1.60b in cash, leading to a CN¥1.40b net cash position.

How Strong Is JNBY Design's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that JNBY Design had liabilities of CN¥1.79b due within 12 months and liabilities of CN¥366.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.60b as well as receivables valued at CN¥210.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥350.6m.

Given JNBY Design has a market capitalization of CN¥5.87b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, JNBY Design also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact JNBY Design's saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 JNBY Design's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While JNBY Design has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, JNBY Design generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that JNBY Design has CN¥1.40b in net cash. And it impressed us with free cash flow of CN¥1.0b, being 90% of its EBIT. So we are not troubled with JNBY Design's debt use. 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. Case in point: We've spotted 3 warning signs for JNBY Design you should be aware of.

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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