Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Jardine Cycle & Carriage Limited (SGX:C07) does have debt on its balance sheet. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Jardine Cycle & Carriage's Net Debt?
As you can see below, at the end of June 2019, Jardine Cycle & Carriage had US$8.11b of debt, up from US$7.03b a year ago. Click the image for more detail. However, because it has a cash reserve of US$1.41b, its net debt is less, at about US$6.69b.
How Healthy Is Jardine Cycle & Carriage's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Jardine Cycle & Carriage had liabilities of US$9.59b due within 12 months and liabilities of US$4.85b due beyond that. On the other hand, it had cash of US$1.41b and US$6.11b worth of receivables due within a year. So its liabilities total US$6.91b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$8.76b, so it does suggest shareholders should keep an eye on Jardine Cycle & Carriage's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Jardine Cycle & Carriage's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 12.8 times, makes us even more comfortable. We saw Jardine Cycle & Carriage grow its EBIT by 5.1% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jardine Cycle & Carriage'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Jardine Cycle & Carriage recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Jardine Cycle & Carriage's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. We think that Jardine Cycle & Carriage's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Given Jardine Cycle & Carriage has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
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