Here's Why El-Mor Electric Installation & Services (1986) (TLV:ELMR) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, El-Mor Electric Installation & Services (1986) Ltd. (TLV:ELMR) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for El-Mor Electric Installation & Services (1986)

What Is El-Mor Electric Installation & Services (1986)'s Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 El-Mor Electric Installation & Services (1986) had debt of ₪24.3m, up from ₪7.65m in one year. However, it does have ₪37.0m in cash offsetting this, leading to net cash of ₪12.7m.

How Healthy Is El-Mor Electric Installation & Services (1986)'s Balance Sheet?

We can see from the most recent balance sheet that El-Mor Electric Installation & Services (1986) had liabilities of ₪170.6m falling due within a year, and liabilities of ₪23.4m due beyond that. On the other hand, it had cash of ₪37.0m and ₪195.3m worth of receivables due within a year. So it can boast ₪38.3m more liquid assets than total liabilities.

This excess liquidity suggests that El-Mor Electric Installation & Services (1986) is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that El-Mor Electric Installation & Services (1986) has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that El-Mor Electric Installation & Services (1986) has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is El-Mor Electric Installation & Services (1986)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While El-Mor Electric Installation & Services (1986) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, El-Mor Electric Installation & Services (1986)'s free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case El-Mor Electric Installation & Services (1986) has ₪12.7m in net cash and a decent-looking balance sheet. So we are not troubled with El-Mor Electric Installation & Services (1986)'s debt use. 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. To that end, you should learn about the 3 warning signs we've spotted with El-Mor Electric Installation & Services (1986) (including 1 which is potentially serious) .

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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