Jewett-Cameron Trading (NASDAQ:JCTC.F) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Jewett-Cameron Trading Company Ltd. (NASDAQ:JCTC.F) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Jewett-Cameron Trading

What Is Jewett-Cameron Trading's Net Debt?

The image below, which you can click on for greater detail, shows that at November 2021 Jewett-Cameron Trading had debt of US$5.00m, up from US$680.7k in one year. However, it also had US$1.24m in cash, and so its net debt is US$3.76m.

How Strong Is Jewett-Cameron Trading's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jewett-Cameron Trading had liabilities of US$8.68m due within 12 months and liabilities of US$125.8k due beyond that. On the other hand, it had cash of US$1.24m and US$5.81m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.76m.

Of course, Jewett-Cameron Trading has a market capitalization of US$23.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Jewett-Cameron Trading has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 114 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Jewett-Cameron Trading's load is not too heavy, because its EBIT was down 41% 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 you can't view debt in total isolation; since Jewett-Cameron Trading 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Jewett-Cameron Trading burned a lot of cash. 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

Jewett-Cameron Trading's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think Jewett-Cameron Trading's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 4 warning signs we've spotted with Jewett-Cameron Trading (including 1 which doesn't sit too well with us) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.