Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that South Jersey Industries, Inc. (NYSE: SJI) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for South Jersey Industries
What is the net debt of South Jersey Industries?
You can click on the graph below for the historical numbers, but it shows that as of June 2021, South Jersey Industries was in debt of $ 3.30 billion, an increase from $ 3.16 billion, over a year. However, he also had $ 87.9 million in cash, so his net debt is $ 3.21 billion.
A look at the responsibilities of South Jersey Industries
The latest balance sheet data shows South Jersey Industries had liabilities of US $ 589.6 million due within one year, and liabilities of US $ 4.35 billion due thereafter. In compensation for these obligations, he had cash of US $ 87.9 million as well as receivables valued at US $ 249.6 million at 12 months. Thus, its liabilities exceed the sum of its cash and its (short-term) receivables by 4.60 billion dollars.
This deficit casts a shadow over the $ 2.23 billion company, like a colossus towering over mere mortals. So we would be watching its record closely, without a doubt. After all, South Jersey Industries would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a net debt to EBITDA ratio of 6.4, it’s fair to say that South Jersey Industries has significant debt. However, its 2.5 interest coverage is reasonably strong, which is a good sign. On the other hand, South Jersey Industries increased its EBIT by 22% last year. If sustained, this growth should cause this debt to evaporate like scarce drinking water during an unusually hot summer. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether South Jersey Industries can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, South Jersey Industries has experienced substantial total negative free cash flow. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
At first glance, South Jersey Industries’ EBIT conversion to free cash flow left us hesitant about the stock, and its total liability level was no more appealing than the single empty restaurant on the busiest night of the year. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. It should also be noted that companies in the gas utility sector like South Jersey Industries generally use debt without a problem. We’re pretty clear that we consider South Jersey Industries to be really rather risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor 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 off the balance sheet. For example, we discovered 4 warning signs for South Jersey Industries (1 is a little worrying!) That you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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