Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies The St. Joe Company (NYSE:JOE) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does St. Joe Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 St. Joe had US$373.6m of debt, an increase on US$320.6m, over one year. On the flip side, it has US$130.2m in cash leading to net debt of about US$243.3m.
How Healthy Is St. Joe’s Balance Sheet?
According to the last reported balance sheet, St. Joe had liabilities of US$49.8m due within 12 months, and liabilities of US$488.2m due beyond 12 months. Offsetting this, it had US$130.2m in cash and US$52.2m in receivables that were due within 12 months. So its liabilities total US$355.5m more than the combination of its cash and short-term receivables.
Of course, St. Joe has a market capitalization of US$2.83b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
St. Joe has net debt to EBITDA of 2.6 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.6 suggests it can easily service that debt. Notably, St. Joe’s EBIT launched higher than Elon Musk, gaining a whopping 121% on last year. There’s no doubt that we learn most about debt from the balance sheet. But it is St. Joe’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, St. Joe recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Our View
Happily, St. Joe’s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Zooming out, St. Joe seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start.
