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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Johnson Service Group PLC (LON:JSG) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Johnson Service Group
How Much Debt Does Johnson Service Group Carry?
As you can see below, Johnson Service Group had UK£96.5m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have UK£9.80m in cash offsetting this, leading to net debt of about UK£86.7m.
How Strong Is Johnson Service Group's Balance Sheet?
The latest balance sheet data shows that Johnson Service Group had liabilities of UK£93.0m due within a year, and liabilities of UK£143.9m falling due after that. Offsetting these obligations, it had cash of UK£9.80m as well as receivables valued at UK£57.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£170.1m.
This deficit isn't so bad because Johnson Service Group is worth UK£637.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.