Here's Why J D Wetherspoon (LON:JDW) Has A Meaningful Debt Burden

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.' 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. Importantly, J D Wetherspoon plc (LON:JDW) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for J D Wetherspoon

What Is J D Wetherspoon's Net Debt?

As you can see below, J D Wetherspoon had UK£723.9m of debt, at July 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have UK£57.2m in cash offsetting this, leading to net debt of about UK£666.7m.

How Healthy Is J D Wetherspoon's Balance Sheet?

The latest balance sheet data shows that J D Wetherspoon had liabilities of UK£351.4m due within a year, and liabilities of UK£1.15b falling due after that. On the other hand, it had cash of UK£57.2m and UK£14.9m worth of receivables due within a year. So its liabilities total UK£1.43b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£731.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, J D Wetherspoon would probably need a major re-capitalization if its creditors were to demand repayment.

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.

While J D Wetherspoon's debt to EBITDA ratio (3.2) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, J D Wetherspoon boosted its EBIT by a silky 34% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine J D Wetherspoon'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, J D Wetherspoon actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

While J D Wetherspoon's level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think J D Wetherspoon's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for J D Wetherspoon (of which 1 is a bit unpleasant!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.