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 can see that JinkoSolar Holding Co., Ltd. (NYSE: JKS) uses debt in its operations. But should shareholders worry about its use of debt?
When is debt a problem?
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. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
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What is JinkoSolar Holding’s debt?
You can click on the graph below for historical numbers, but it shows that in June 2022, JinkoSolar Holding had a debt of 52.1 billion Canadian yen, an increase from 28.6 billion Canadian yen, over a year. However, he also had 13.4 billion yen in cash, so his net debt is 38.7 billion yen.
A look at the liabilities of JinkoSolar Holding
According to the latest published balance sheet, JinkoSolar Holding had liabilities of 62.9 billion Canadian yen due within 12 months and liabilities of 15.6 billion Canadian yen due beyond 12 months. As compensation for these obligations, it had cash of 13.4 billion Canadian yen as well as receivables worth 14.0 billion national yen due within 12 months. Thus, its liabilities total 51.1 billion Canadian yen more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CN¥18.1b company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, JinkoSolar Holding would likely need a major recapitalization if it were to pay its creditors today.
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
JinkoSolar Holding shareholders face the double whammy of a high net debt to EBITDA ratio (15.3) and quite low interest coverage, as EBIT is only 1.2 times expenses of interests. The debt burden here is considerable. Worse still, JinkoSolar Holding’s EBIT was down 52% from a year ago. If profits continue like this in the long term, there is an unimaginable chance of repaying this debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether JinkoSolar Holding 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.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, JinkoSolar Holding has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, JinkoSolar Holding’s EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. Moreover, its interest coverage also fails to inspire confidence. It seems to us that JinkoSolar Holding carries a heavy burden on the balance sheet. If you harvest honey without a bee suit, you might get stung, so we’ll probably stay away from that particular stock. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for JinkoSolar Holding (1 should not be ignored!) which you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.
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