Here's Why Jardine Cycle & Carriage (SGX:C07) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Jardine Cycle & Carriage Limited (SGX:C07) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.

See our latest analysis for Jardine Cycle & Carriage

What Is Jardine Cycle & Carriage's Debt?

The image below, which you can click on for greater detail, shows that Jardine Cycle & Carriage had debt of US$6.90b at the end of June 2021, a reduction from US$7.54b over a year. On the flip side, it has US$3.83b in cash leading to net debt of about US$3.07b.

A Look At Jardine Cycle & Carriage's Liabilities

The latest balance sheet data shows that Jardine Cycle & Carriage had liabilities of US$7.11b due within a year, and liabilities of US$5.29b falling due after that. Offsetting this, it had US$3.83b in cash and US$5.07b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.50b.

While this might seem like a lot, it is not so bad since Jardine Cycle & Carriage has a market capitalization of US$5.93b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jardine Cycle & Carriage has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 77.8 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Jardine Cycle & Carriage's load is not too heavy, because its EBIT was down 40% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

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. Happily for any shareholders, Jardine Cycle & Carriage actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen Jardine Cycle & Carriage is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Jardine Cycle & Carriage's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Jardine Cycle & Carriage is showing 3 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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