Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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. As with many other companies JD.com, Inc. (NASDAQ:JD) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is JD.com's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 JD.com had CN¥10.2b of debt, an increase on CN¥19.5k, over one year. But on the other hand it also has CN¥56.6b in cash, leading to a CN¥46.4b net cash position.
A Look At JD.com's Liabilities
We can see from the most recent balance sheet that JD.com had liabilities of CN¥132.8b falling due within a year, and liabilities of CN¥19.3b due beyond that. Offsetting these obligations, it had cash of CN¥56.6b as well as receivables valued at CN¥17.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥78.4b.
This deficit isn't so bad because JD.com is worth a massive CN¥388.4b, and thus could probably raise enough capital to shore up 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. Despite its noteworthy liabilities, JD.com boasts net cash, so it's fair to say it does not have a heavy debt load!
Although JD.com made a loss at the EBIT level, last year, it was also good to see that it generated CN¥4.5b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine JD.com'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. JD.com 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 year, JD.com actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although JD.com's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥46.4b. The cherry on top was that in converted 447% of that EBIT to free cash flow, bringing in CN¥20b. So we don't think JD.com's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in JD.com, you may well want to click here to check an interactive graph of its earnings per share history.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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