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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Jabil Inc. (NYSE: JBL) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Jabil
What is Jabil’s net debt?
You can click on the graph below for historical numbers, but it shows that as of May 2021, Jabil had $ 2.95 billion in debt, an increase from $ 2.54 billion, year on year. . However, it has $ 1.26 billion in cash offsetting that, leading to net debt of around $ 1.70 billion.
Is Jabil’s track record healthy?
We can see from the most recent balance sheet that Jabil had liabilities of US $ 9.85 billion maturing within one year and liabilities of US $ 3.75 billion maturing beyond that. In compensation for these obligations, it had cash of US $ 1.26 billion as well as receivables valued at US $ 4.30 billion within 12 months. Its liabilities therefore total $ 8.05 billion more than the combination of its cash and short-term receivables.
This deficit is sizable compared to his market cap of $ 9.07 billion, so he suggests shareholders keep an eye on Jabil’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.
With net debt of just 0.86 times EBITDA, Jabil is arguably fairly cautious. And it has 8.7 times interest coverage, which is more than enough. On top of that, Jabil has increased its EBIT by 63% over the past twelve months, and this growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Jabil can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Jabil has reported free cash flow of 12% of its EBIT, which is really pretty low. This low level of cash conversion undermines its ability to manage and repay its debts.
Our point of view
When it comes to the balance sheet, the biggest bright spot for Jabil was the fact that he seems able to increase his EBIT with confidence. However, our other observations were not so encouraging. For example, it looks like he’s having a little trouble converting EBIT to free cash flow. Looking at all of this data, we feel a little cautious about Jabil’s debt levels. While debt has its advantage in terms of potential higher returns, we think shareholders should definitely consider how leverage levels might make the stock riskier. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Know that Jabil shows 1 warning sign in our investment analysis , you must know…
If you want to invest in businesses that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St does not have any position in the mentioned stocks.
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