Is E. Schnapp Works (TLV:SHNP) Using Too Much Debt?

By
Simply Wall St
Published
May 13, 2021
TASE:SHNP
Source: Shutterstock

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.' 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. Importantly, E. Schnapp & Co. Works Ltd (TLV:SHNP) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for E. Schnapp Works

What Is E. Schnapp Works's Net Debt?

As you can see below, E. Schnapp Works had ₪108.9m of debt at December 2020, down from ₪159.8m a year prior. On the flip side, it has ₪10.0m in cash leading to net debt of about ₪98.9m.

debt-equity-history-analysis
TASE:SHNP Debt to Equity History May 14th 2021

How Healthy Is E. Schnapp Works' Balance Sheet?

We can see from the most recent balance sheet that E. Schnapp Works had liabilities of ₪129.9m falling due within a year, and liabilities of ₪70.3m due beyond that. On the other hand, it had cash of ₪10.0m and ₪179.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪10.5m.

Given E. Schnapp Works has a market capitalization of ₪205.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

E. Schnapp Works's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its strong interest cover of 17.2 times, makes us even more comfortable. It is well worth noting that E. Schnapp Works's EBIT shot up like bamboo after rain, gaining 40% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is E. Schnapp Works's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term 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, E. Schnapp Works actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

E. Schnapp Works's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think E. Schnapp Works is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for E. Schnapp Works (1 doesn't sit too well with us!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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