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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that JetBlue Airways Corporation (NASDAQ:JBLU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is JetBlue Airways’s Net Debt?
As you can see below, at the end of March 2019, JetBlue Airways had US$1.54b of debt, up from US$1.14b a year ago. Click the image for more detail. However, it also had US$876.0m in cash, and so its net debt is US$663.0m.
How Strong Is JetBlue Airways’s Balance Sheet?
We can see from the most recent balance sheet that JetBlue Airways had liabilities of US$2.85b falling due within a year, and liabilities of US$3.66b due beyond that. Offsetting this, it had US$876.0m in cash and US$338.0m in receivables that were due within 12 months. So it has liabilities totalling US$5.29b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$5.56b, so it does suggest shareholders should keep an eye on JetBlue Airways’s use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. Since JetBlue Airways does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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). 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).
With net debt sitting at just 0.58 times EBITDA, JetBlue Airways is arguably pretty conservatively geared. And it boasts interest cover of 9.27 times, which is more than adequate. In fact JetBlue Airways’s saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 JetBlue Airways’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 it’s worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, JetBlue Airways recorded free cash flow of 27% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
We’d go so far as to say JetBlue Airways’s EBIT growth rate was disappointing. But at least it’s pretty decent at covering its interest expense with its EBIT; that’s encouraging. Overall, we think it’s fair to say that JetBlue Airways has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. In light of our reservations about the company’s balance sheet, it seems sensible to check if insiders have been selling shares recently.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.