David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Jardine Cycle & Carriage Limited (SGX:C07) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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.
Check out our latest analysis for Jardine Cycle & Carriage
What Is Jardine Cycle & Carriage's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Jardine Cycle & Carriage had US$6.56b of debt in December 2021, down from US$7.13b, one year before. However, it does have US$4.26b in cash offsetting this, leading to net debt of about US$2.30b.SGX:C07 Debt to Equity History June 16th 2022
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$7.58b due within 12 months and liabilities of US$5.08b due beyond that. On the other hand, it had cash of US$4.26b and US$2.86b worth of receivables due within a year. So its liabilities total US$5.54b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$8.76b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Jardine Cycle & Carriage's net debt is only 0.91 times its EBITDA. And its EBIT easily covers its interest expense, being 101 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that Jardine Cycle & Carriage grew its EBIT at 12% over the last year, further increasing its ability to manage 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're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow . Over the last three years, Jardine Cycle & Carriage actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Jardine Cycle & Carriage's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Jardine Cycle & Carriage takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Jardine Cycle & Carriage that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.