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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Jesco Holdings, Inc. (TSE:1434) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Jesco Holdings
What Is Jesco Holdings's Debt?
As you can see below, Jesco Holdings had JP¥6.85b of debt at November 2024, down from JP¥7.27b a year prior. However, it also had JP¥3.20b in cash, and so its net debt is JP¥3.65b.
How Strong Is Jesco Holdings' Balance Sheet?
We can see from the most recent balance sheet that Jesco Holdings had liabilities of JP¥6.05b falling due within a year, and liabilities of JP¥5.46b due beyond that. On the other hand, it had cash of JP¥3.20b and JP¥3.08b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥5.23b.
This is a mountain of leverage relative to its market capitalization of JP¥5.91b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Jesco Holdings's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its commanding EBIT of 41.6 times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Jesco Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 284% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jesco Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Jesco Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
We feel some trepidation about Jesco Holdings's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its interest cover and EBIT growth rate were encouraging signs. We think that Jesco Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 Jesco Holdings has 5 warning signs (and 2 which are a bit unpleasant) we think 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.
About TSE:1434
Jesco Holdings
Engages in the electrical equipment construction business.
Moderate with mediocre balance sheet.