We Think JAKKS Pacific (NASDAQ:JAKK) Can Manage Its Debt With Ease

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, JAKKS Pacific, Inc. (NASDAQ:JAKK) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for JAKKS Pacific

What Is JAKKS Pacific's Net Debt?

You can click the graphic below for the historical numbers, but it shows that JAKKS Pacific had US$67.2m of debt in December 2022, down from US$95.5m, one year before. However, it does have US$85.3m in cash offsetting this, leading to net cash of US$18.1m.

A Look At JAKKS Pacific's Liabilities

The latest balance sheet data shows that JAKKS Pacific had liabilities of US$177.8m due within a year, and liabilities of US$76.3m falling due after that. On the other hand, it had cash of US$85.3m and US$105.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$63.9m.

JAKKS Pacific has a market capitalization of US$209.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, JAKKS Pacific boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, JAKKS Pacific grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if JAKKS Pacific can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. JAKKS Pacific 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 three years, JAKKS Pacific recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While JAKKS Pacific does have more liabilities than liquid assets, it also has net cash of US$18.1m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$76m. So is JAKKS Pacific's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for JAKKS Pacific (of which 1 is potentially serious!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.