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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Meshulam Levinstein Contracting & Engineering Ltd. (TLV:LEVI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Meshulam Levinstein Contracting & Engineering's Debt?
The image below, which you can click on for greater detail, shows that Meshulam Levinstein Contracting & Engineering had debt of ₪943.6m at the end of March 2021, a reduction from ₪1.09b over a year. However, it does have ₪112.5m in cash offsetting this, leading to net debt of about ₪831.1m.
A Look At Meshulam Levinstein Contracting & Engineering's Liabilities
Zooming in on the latest balance sheet data, we can see that Meshulam Levinstein Contracting & Engineering had liabilities of ₪630.6m due within 12 months and liabilities of ₪720.9m due beyond that. On the other hand, it had cash of ₪112.5m and ₪188.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪1.05b.
When you consider that this deficiency exceeds the company's ₪980.4m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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.
Meshulam Levinstein Contracting & Engineering has a rather high debt to EBITDA ratio of 6.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 5.0 times, suggesting it can responsibly service its obligations. We saw Meshulam Levinstein Contracting & Engineering grow its EBIT by 7.7% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Meshulam Levinstein Contracting & Engineering'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Meshulam Levinstein Contracting & Engineering produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Meshulam Levinstein Contracting & Engineering's net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to convert EBIT to free cash flow isn't too shabby at all. Taking the abovementioned factors together we do think Meshulam Levinstein Contracting & Engineering'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Meshulam Levinstein Contracting & Engineering (1 is a bit unpleasant) 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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