These 4 Measures Indicate That Johnson Controls-Hitachi Air Conditioning India (NSE:JCHAC) Is Using Debt Extensively

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. Importantly, Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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

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

You can click the graphic below for the historical numbers, but it shows that Johnson Controls-Hitachi Air Conditioning India had ₹1.59b of debt in March 2020, down from ₹1.90b, one year before. However, it also had ₹414.2m in cash, and so its net debt is ₹1.17b.

How Strong Is Johnson Controls-Hitachi Air Conditioning India's Balance Sheet?

The latest balance sheet data shows that Johnson Controls-Hitachi Air Conditioning India had liabilities of ₹7.99b due within a year, and liabilities of ₹970.2m falling due after that. Offsetting this, it had ₹414.2m in cash and ₹2.67b in receivables that were due within 12 months. So it has liabilities totalling ₹5.87b more than its cash and near-term receivables, combined.

Since publicly traded Johnson Controls-Hitachi Air Conditioning India shares are worth a total of ₹61.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

Johnson Controls-Hitachi Air Conditioning India has a low net debt to EBITDA ratio of only 0.68. And its EBIT covers its interest expense a whopping 23.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Johnson Controls-Hitachi Air Conditioning India saw its EBIT drop by 9.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Johnson Controls-Hitachi Air Conditioning India's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Johnson Controls-Hitachi Air Conditioning India burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Johnson Controls-Hitachi Air Conditioning India's ability to convert EBIT to free cash flow nor its EBIT growth rate gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We think that Johnson Controls-Hitachi Air Conditioning India'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. Over time, share prices tend to follow earnings per share, so if you're interested in Johnson Controls-Hitachi Air Conditioning India, you may well want to click here to check an interactive graph of its earnings per share history.

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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