These 4 Measures Indicate That Averbuch Formica Center (TLV:AVER) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Averbuch Formica Center Ltd. (TLV:AVER) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Averbuch Formica Center

What Is Averbuch Formica Center's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Averbuch Formica Center had ₪17.9m of debt, an increase on ₪13.9m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Averbuch Formica Center's Liabilities

Zooming in on the latest balance sheet data, we can see that Averbuch Formica Center had liabilities of ₪15.3m due within 12 months and liabilities of ₪14.2m due beyond that. On the other hand, it had cash of ₪352.0k and ₪7.86m worth of receivables due within a year. So it has liabilities totalling ₪21.3m more than its cash and near-term receivables, combined.

Of course, Averbuch Formica Center has a market capitalization of ₪122.0m, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Averbuch Formica Center has a sky high EBITDA ratio of 7.2, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Averbuch Formica Center made a loss at the EBIT level, last year, but improved that to positive EBIT of ₪126k in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Averbuch Formica Center will need earnings to service that debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Averbuch Formica Center saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Averbuch Formica Center's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Averbuch Formica Center's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Averbuch Formica Center (of which 1 is concerning!) you should know about.

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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