Johnson Electric Holdings (HKG:179) seems to be using debt quite wisely
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We notice that Johnson Electric Holdings Limited (HKG:179) has a debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own 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) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Johnson Electric Holdings
How much debt does Johnson Electric Holdings have?
The image below, which you can click on for more details, shows that as of September 2021, Johnson Electric Holdings had $510.0 million in debt, up from $432.6 million in one year. However, since he has a cash reserve of $498.7 million, his net debt is less, at around $11.3 million.
How strong is Johnson Electric Holdings’ balance sheet?
According to the last published balance sheet, Johnson Electric Holdings had liabilities of $1.07 billion due within 12 months and liabilities of $801.4 million due beyond 12 months. On the other hand, it had a cash position of 498.7 million dollars and 597.6 million dollars of receivables at less than one year. Thus, its liabilities total $776.4 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not too bad since Johnson Electric Holdings has a market capitalization of US$1.80 billion, so it could probably bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay debt. Carrying virtually no net debt, Johnson Electric Holdings indeed has very light debt.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With debt at a measly 0.025 times EBITDA and EBIT covering interest at 14.7 times, it’s clear that Johnson Electric Holdings is not a desperate borrower. Thus, compared to previous income, the level of indebtedness seems insignificant. In contrast, Johnson Electric Holdings’ EBIT has fallen 12% over the past year. We believe that this type of performance, if repeated frequently, could well spell trouble for the stock. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Johnson Electric Holdings 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. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Johnson Electric Holdings has produced strong free cash flow equivalent to 64% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Johnson Electric Holdings’ ability to cover its interest expense with its EBIT and net debt to EBITDA has given us comfort in its ability to manage its debt. On the other hand, our confidence was shaken by its apparent struggle to increase its EBIT. When you consider all of the items mentioned above, it seems to us that Johnson Electric Holdings is managing its debt quite well. But be warned: we believe debt levels are high enough to warrant continued monitoring. 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. Example: we have identified 1 warning sign for Johnson Electric Holdings you should be aware.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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.