Is Jeudan (CPH:JDAN) Using Too Much Debt?

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. As with many other companies Jeudan A/S (CPH:JDAN) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Jeudan

What Is Jeudan's Debt?

The chart below, which you can click on for greater detail, shows that Jeudan had kr.18.3b in debt in September 2020; about the same as the year before. On the flip side, it has kr.426.0m in cash leading to net debt of about kr.17.9b.

How Strong Is Jeudan's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jeudan had liabilities of kr.1.38b due within 12 months and liabilities of kr.19.1b due beyond that. Offsetting this, it had kr.426.0m in cash and kr.224.4m in receivables that were due within 12 months. So it has liabilities totalling kr.19.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the kr.13.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Jeudan would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jeudan's net debt to EBITDA ratio is 20.6 which suggests rather high debt levels, but its interest cover of 8.6 times suggests the debt is easily serviced. Our best guess is that the company does indeed have significant debt obligations. Jeudan grew its EBIT by 2.1% in the last year. 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 you can't view debt in total isolation; since Jeudan will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Jeudan recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

On the face of it, Jeudan's level of total liabilities left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Jeudan stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Jeudan (1 makes us a bit uncomfortable) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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