Is Johnson Controls-Hitachi Air Conditioning India (NSE:JCHAC) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Johnson Controls-Hitachi Air Conditioning India

How Much Debt Does Johnson Controls-Hitachi Air Conditioning India Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Johnson Controls-Hitachi Air Conditioning India had debt of ₹1.25b, up from ₹301.9m in one year. However, because it has a cash reserve of ₹195.9m, its net debt is less, at about ₹1.05b.

A Look At Johnson Controls-Hitachi Air Conditioning India's Liabilities

We can see from the most recent balance sheet that Johnson Controls-Hitachi Air Conditioning India had liabilities of ₹4.47b falling due within a year, and liabilities of ₹1.19b due beyond that. Offsetting these obligations, it had cash of ₹195.9m as well as receivables valued at ₹1.30b due within 12 months. So its liabilities total ₹4.16b more than the combination of its cash and short-term receivables.

Given Johnson Controls-Hitachi Air Conditioning India has a market capitalization of ₹72.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Johnson Controls-Hitachi Air Conditioning India has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Johnson Controls-Hitachi Air Conditioning India's debt is only 1.7, its interest cover is really very low at 1.4. In large part that's it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. Importantly, Johnson Controls-Hitachi Air Conditioning India's EBIT fell a jaw-dropping 93% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Johnson Controls-Hitachi Air Conditioning India will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last three years, Johnson Controls-Hitachi Air Conditioning India saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Johnson Controls-Hitachi Air Conditioning India's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Overall, we think it's fair to say that Johnson Controls-Hitachi Air Conditioning India has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Johnson Controls-Hitachi Air Conditioning India has 1 warning sign we think 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.

If you’re looking to trade Johnson Controls-Hitachi Air Conditioning India, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.