The fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, emphasizes that the biggest investment risk is not price volatility, but the potential for a permanent loss of capital. When evaluating a company’s risk level, it is important to consider its use of debt, as excessive debt can lead to financial ruin. JD.com, Inc. (NASDAQ:JD) is one such company that utilizes debt, prompting the question of whether shareholders should be concerned about its debt levels.
Debt can be beneficial for a business until it becomes difficult to repay, either through new capital or free cash flow. In the worst-case scenario, a company may go bankrupt if it cannot meet its financial obligations. Alternatively, it may have to issue new equity at a lower price, thereby diluting shareholder value. However, many companies successfully use debt to fuel growth without negative repercussions. When assessing a company’s debt, it is essential to consider both its cash holdings and debt levels.
As of December 2023, JD.com had CN¥47.0b in debt, an increase from CN¥42.4b the previous year. However, the company also had CN¥190.1b in cash, resulting in CN¥143.1b in net cash.
On its balance sheet, JD.com reported liabilities of CN¥265.7b due within 12 months and CN¥66.9b due beyond 12 months. In contrast, it held CN¥190.1b in cash and CN¥24.1b in receivables due within a year. While its liabilities exceed its cash and receivables by CN¥118.3b, JD.com’s substantial market capitalization of CN¥356.1b suggests it could raise capital if necessary. Despite its significant liabilities, JD.com maintains a healthy net cash position, indicating a manageable debt load.
Furthermore, JD.com’s EBIT increased by 58%, reducing concerns about future debt repayments. While the balance sheet provides valuable insight into a company’s debt, its future profitability ultimately determines its ability to strengthen its financial position over time. JD.com’s ability to generate free cash flow exceeding EBIT over the past three years is a positive indicator of its capacity to manage debt effectively.
In conclusion, while JD.com’s balance sheet may not be exceptionally strong due to its total liabilities, its substantial net cash of CN¥143.1b and impressive free cash flow of CN¥34b (168% of EBIT) mitigate concerns about its debt risk. When evaluating debt levels, the balance sheet is a crucial starting point, but other factors also influence investment risk. Investors should be aware of potential warning signs, such as those identified for JD.com. For those interested in debt-free growth opportunities, exploring a list of growing businesses with net cash on their balance sheets may offer valuable investment prospects.