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. Importantly, Scholastic Corporation (NASDAQ:SCHL) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.

What Is Scholastic’s Debt?

You can click the graphic below for the historical numbers, but it shows that Scholastic had US$14.3m of debt in November 2021, down from US$194.8m, one year before. However, its balance sheet shows it holds US$300.7m in cash, so it actually has US$286.4m net cash.

How Strong Is Scholastic’s Balance Sheet?

According to the last reported balance sheet, Scholastic had liabilities of US$671.7m due within 12 months, and liabilities of US$99.0m due beyond 12 months. Offsetting this, it had US$300.7m in cash and US$383.1m in receivables that were due within 12 months. So its liabilities total US$86.9m more than the combination of its cash and short-term receivables.

Since publicly traded Scholastic shares are worth a total of US$1.48b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Scholastic also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Although Scholastic made a loss at the EBIT level, last year, it was also good to see that it generated US$50m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Scholastic’s earnings that will influence how the balance sheet holds up in the future.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Scholastic 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, Scholastic actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Scholastic has US$286.4m in net cash. And it impressed us with free cash flow of US$153m, being 305% of its EBIT. So is Scholastic’s debt a risk? It doesn’t seem so to us.