Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that New Jersey Resource Company (NYSE: NJR) uses debt in its operations. But does this debt worry shareholders?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
How much debt does New Jersey Resources have?
The image below, which you can click on for more details, shows that in June 2022, New Jersey Resources had $2.89 billion in debt, up from $2.40 billion in one year. Net debt is about the same, since she doesn’t have a lot of cash.
How healthy is New Jersey Resources’ balance sheet?
Zooming in on the latest balance sheet data, we can see that New Jersey Resources had liabilities of US$969.4 million due within 12 months and liabilities of US$3.42 billion due beyond. On the other hand, it had $27.7 million in cash and $274.9 million in receivables within one year. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $4.09 billion.
Given that this deficit is actually larger than the company’s market capitalization of $4.06 billion, we think shareholders really should be watching New Jersey Resources’ debt levels, like a parent watching their child do. cycling for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
New Jersey Resources has a rather high debt-to-EBITDA ratio of 6.3, suggesting significant leverage. But the good news is that it has a pretty heartwarming 4.2x interest coverage, suggesting it can meet its obligations responsibly. Notably, New Jersey Resources’ EBIT has been pretty flat over the past year, which isn’t ideal given the leverage. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether 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 analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, New Jersey Resources has had substantial negative free cash flow, overall. While investors no doubt expect a reversal of this situation in due course, it clearly means that its use of debt is more risky.
Our point of view
At first glance, New Jersey Resources’ net debt to EBITDA left us uncertain about the stock, and its EBIT-to-free-cash-flow conversion was no more appealing than the single restaurant emptying the busiest night of the year. That said, its ability to grow its EBIT is not such a concern. It’s also worth noting that New Jersey Resources is in the gas utility sector, which is often seen as quite defensive. We are quite clear that we consider New Jersey Resources to be quite risky indeed, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with New Jersey Resources (at least 1, which makes us a little uneasy), and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.