Is Jardine Cycle & Carriage (SGX:C07) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Jardine Cycle & Carriage Limited (SGX:C07) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. 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 Jardine Cycle & Carriage

What Is Jardine Cycle & Carriage's Net Debt?

The image below, which you can click on for greater detail, shows that Jardine Cycle & Carriage had debt of US$5.95b at the end of December 2022, a reduction from US$6.56b over a year. However, it does have US$3.66b in cash offsetting this, leading to net debt of about US$2.28b.

How Healthy Is Jardine Cycle & Carriage's Balance Sheet?

The latest balance sheet data shows that Jardine Cycle & Carriage had liabilities of US$8.57b due within a year, and liabilities of US$4.28b falling due after that. Offsetting these obligations, it had cash of US$3.66b as well as receivables valued at US$3.22b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.97b.

While this might seem like a lot, it is not so bad since Jardine Cycle & Carriage has a huge market capitalization of US$10.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Jardine Cycle & Carriage's net debt is only 0.65 times its EBITDA. And its EBIT easily covers its interest expense, being 139 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Jardine Cycle & Carriage grew its EBIT by 60% 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 it is future earnings, more than anything, that will determine Jardine Cycle & Carriage's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Jardine Cycle & Carriage actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Jardine Cycle & Carriage's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, Jardine Cycle & Carriage seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Jardine Cycle & Carriage you should be aware of.

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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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.