We Think JSW Energy (NSE:JSWENERGY) Can Stay On Top Of Its Debt

Published
May 20, 2022
NSEI:JSWENERGY
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that JSW Energy Limited (NSE:JSWENERGY) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for JSW Energy

What Is JSW Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 JSW Energy had ₹88.9b of debt, an increase on ₹83.4b, over one year. On the flip side, it has ₹25.3b in cash leading to net debt of about ₹63.7b.

debt-equity-history-analysis
NSEI:JSWENERGY Debt to Equity History May 20th 2022

How Healthy Is JSW Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that JSW Energy had liabilities of ₹50.9b due within 12 months and liabilities of ₹84.2b due beyond that. Offsetting these obligations, it had cash of ₹25.3b as well as receivables valued at ₹13.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹96.2b.

While this might seem like a lot, it is not so bad since JSW Energy has a market capitalization of ₹439.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

JSW Energy's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 3.1 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, JSW Energy grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if JSW Energy can strengthen its balance sheet over time. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, JSW Energy generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

JSW Energy's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. Taking all this data into account, it seems to us that JSW Energy takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for JSW Energy you should be aware of, and 1 of them is a bit unpleasant.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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