Bet Shemesh Engines Holdings (1997) (TLV:BSEN) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Bet Shemesh Engines Holdings (1997) Ltd (TLV:BSEN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Bet Shemesh Engines Holdings (1997)

How Much Debt Does Bet Shemesh Engines Holdings (1997) Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Bet Shemesh Engines Holdings (1997) had US$70.2m of debt, an increase on US$56.0m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Bet Shemesh Engines Holdings (1997)'s Liabilities

We can see from the most recent balance sheet that Bet Shemesh Engines Holdings (1997) had liabilities of US$72.5m falling due within a year, and liabilities of US$54.8m due beyond that. Offsetting this, it had US$441.0k in cash and US$33.9m in receivables that were due within 12 months. So it has liabilities totalling US$93.0m more than its cash and near-term receivables, combined.

Bet Shemesh Engines Holdings (1997) has a market capitalization of US$183.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Bet Shemesh Engines Holdings (1997) has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 5.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Also relevant is that Bet Shemesh Engines Holdings (1997) has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Bet Shemesh Engines Holdings (1997)'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. During the last three years, Bet Shemesh Engines Holdings (1997) burned a lot of cash. 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

Bet Shemesh Engines Holdings (1997)'s conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its EBIT growth rate was re-invigorating. We think that Bet Shemesh Engines Holdings (1997)'s debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 3 warning signs for Bet Shemesh Engines Holdings (1997) you should be aware of.

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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