Is New Jersey Resources (NYSE:NJR) Using Too Much Debt?

Warren Buffett famously said, '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 can see that New Jersey Resources Corporation (NYSE:NJR) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for New Jersey Resources

What Is New Jersey Resources's Debt?

As you can see below, at the end of September 2022, New Jersey Resources had US$2.95b of debt, up from US$2.59b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At New Jersey Resources' Liabilities

According to the last reported balance sheet, New Jersey Resources had liabilities of US$1.10b due within 12 months, and liabilities of US$3.34b due beyond 12 months. Offsetting these obligations, it had cash of US$1.11m as well as receivables valued at US$231.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.21b.

This deficit is considerable relative to its market capitalization of US$4.79b, so it does suggest shareholders should keep an eye on New Jersey Resources' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

New Jersey Resources has a rather high debt to EBITDA ratio of 5.5 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.9 times, suggesting it can responsibly service its obligations. Importantly, New Jersey Resources grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if New Jersey Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, New Jersey Resources saw substantial negative free cash flow, in total. 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

On the face of it, New Jersey Resources's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that New Jersey Resources is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making New Jersey Resources stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example New Jersey Resources has 3 warning signs (and 1 which is concerning) we think 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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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.