Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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. As with many other companies J.W. Mays, Inc. (NASDAQ:MAYS) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is J.W. Mays’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that J.W. Mays had US$7.23m of debt in October 2021, down from US$9.08m, one year before. However, because it has a cash reserve of US$2.10m, its net debt is less, at about US$5.14m.

How Healthy Is J.W. Mays’ Balance Sheet?

Zooming in on the latest balance sheet data, we can see that J.W. Mays had liabilities of US$4.42m due within 12 months and liabilities of US$37.9m due beyond that. Offsetting these obligations, it had cash of US$2.10m as well as receivables valued at US$2.31m due within 12 months. So it has liabilities totalling US$37.9m more than its cash and near-term receivables, combined.

J.W. Mays has a market capitalization of US$85.0m, so it could very likely raise cash to ameliorate 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is J.W. Mays’s earnings that will influence how the balance sheet holds up in the future.

Over 12 months, J.W. Mays reported revenue of US$20m, which is a gain of 5.8%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months J.W. Mays produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$883k at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of US$1.2m and a profit of US$423k. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble.