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.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies JAKKS Pacific, Inc. (NASDAQ:JAKK) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for JAKKS Pacific
How Much Debt Does JAKKS Pacific Carry?
You can click the graphic below for the historical numbers, but it shows that JAKKS Pacific had US$67.7m of debt in September 2022, down from US$95.8m, one year before. But on the other hand it also has US$76.4m in cash, leading to a US$8.75m net cash position.
A Look At JAKKS Pacific’s Liabilities
We can see from the most recent balance sheet that JAKKS Pacific had liabilities of US$265.4m falling due within a year, and liabilities of US$101.2m due beyond that. Offsetting this, it had US$76.4m in cash and US$207.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$83.1m.
JAKKS Pacific has a market capitalization of US$191.6m, 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!
Even more impressive was the fact that JAKKS Pacific grew its EBIT by 116% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine JAKKS Pacific’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. While JAKKS Pacific 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, JAKKS Pacific produced sturdy free cash flow equating to 64% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While JAKKS Pacific does have more liabilities than liquid assets, it also has net cash of US$8.75m. And we liked the look of last year’s 116% year-on-year EBIT growth. So we don’t have any problem with JAKKS Pacific’s use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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 a bit concerning!) you should know about.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
What are the risks and opportunities for JAKKS Pacific?
Trading at 35.8% below our estimate of its fair value
Became profitable this year
Earnings are forecast to decline by an average of 0.9% per year for the next 3 years
Shareholders have been diluted in the past year
View all Risks and Rewards
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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.