We Think Hamat Group (TLV:HAMAT) Can Stay On Top Of Its Debt

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 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, Hamat Group Ltd. (TLV:HAMAT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Hamat Group

What Is Hamat Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Hamat Group had ₪298.3m of debt, an increase on ₪241.9m, over one year. However, because it has a cash reserve of ₪29.6m, its net debt is less, at about ₪268.7m.

How Healthy Is Hamat Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hamat Group had liabilities of ₪486.4m due within 12 months and liabilities of ₪169.8m due beyond that. On the other hand, it had cash of ₪29.6m and ₪239.6m worth of receivables due within a year. So it has liabilities totalling ₪387.0m more than its cash and near-term receivables, combined.

Hamat Group has a market capitalization of ₪704.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hamat Group has net debt to EBITDA of 2.6 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.3 suggests it can easily service that debt. It is well worth noting that Hamat Group's EBIT shot up like bamboo after rain, gaining 85% 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 you can't view debt in total isolation; since Hamat Group 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Hamat Group's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Hamat Group was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think Hamat Group is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Hamat Group (of which 1 shouldn't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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