Here’s Why Johnson Matthey (LON: JMAT) Can Responsibly Manage Debt
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will 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 notice that Johnson matthey plc (LON: JMAT) has debt on its balance sheet. But does this debt worry shareholders?
When is Debt a Problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company can’t meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. 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 analysis for Johnson Matthey
What is Johnson Matthey’s debt?
You can click on the graph below for historical figures, but it shows Johnson Matthey was in debt of Â£ 1.41bn in September 2021, up from Â£ 1.62bn a year earlier. However, he also had Â£ 749.0million in cash, so his net debt is Â£ 656.0million.
How strong is Johnson Matthey’s balance sheet?
According to the latest published balance sheet, Johnson Matthey had a liability of Â£ 3.58bn due within 12 months and a liability of Â£ 1.26bn due beyond 12 months. On the other hand, he had Â£ 749.0million in cash and Â£ 1.82 billion in debts due within one year. Its liabilities therefore total Â£ 2.27 billion more than the combination of its cash and short-term receivables.
This deficit is not that big as Johnson Matthey is worth Â£ 3.85bn, and could therefore probably raise enough capital to consolidate his balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
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.
Johnson Matthey has net debt of just 0.82 times EBITDA, indicating that he is certainly not a reckless borrower. And it has 9.3 times interest coverage, which is more than enough. On top of that, Johnson Matthey has increased its EBIT by 56% over the past twelve months, and that growth will make it easier to process its debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether Johnson Matthey can strengthen his 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 needs free cash flow to pay off debts; accounting profits are not enough. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Johnson Matthey has recorded free cash flow of 61% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Johnson Matthey’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But, on a darker note, we’re a little concerned with its total liability level. Given all of this data, it seems to us that Johnson Matthey is taking a pretty sane approach to debt. While this carries some risk, it can also improve returns for shareholders. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for Johnson Matthey which you should know before investing here.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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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 any stock 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 documents. Simply Wall St has no position in any of the stocks mentioned.