Is Birman Wood & Hardware (TLV:BIRM) Using Too Much Debt?

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. We note that Birman Wood & Hardware Ltd (TLV:BIRM) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Birman Wood & Hardware

How Much Debt Does Birman Wood & Hardware Carry?

The chart below, which you can click on for greater detail, shows that Birman Wood & Hardware had ₪298.7m in debt in June 2023; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Birman Wood & Hardware's Balance Sheet?

According to the last reported balance sheet, Birman Wood & Hardware had liabilities of ₪298.3m due within 12 months, and liabilities of ₪52.8m due beyond 12 months. Offsetting these obligations, it had cash of ₪144.0k as well as receivables valued at ₪168.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪182.2m.

This deficit casts a shadow over the ₪116.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Birman Wood & Hardware would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Birman Wood & Hardware shareholders face the double whammy of a high net debt to EBITDA ratio (11.8), and fairly weak interest coverage, since EBIT is just 1.5 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Birman Wood & Hardware's EBIT was down 74% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Birman Wood & Hardware'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Birman Wood & Hardware 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

On the face of it, Birman Wood & Hardware's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Birman Wood & Hardware is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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 Birman Wood & Hardware has 5 warning signs (and 3 which are potentially serious) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.