Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Shikun & Binui Ltd. (TLV:SKBN) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is Shikun & Binui's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Shikun & Binui had ₪11.0b of debt, an increase on ₪9.36b, over one year. On the flip side, it has ₪2.81b in cash leading to net debt of about ₪8.18b.
A Look At Shikun & Binui's Liabilities
According to the last reported balance sheet, Shikun & Binui had liabilities of ₪6.67b due within 12 months, and liabilities of ₪9.23b due beyond 12 months. Offsetting these obligations, it had cash of ₪2.81b as well as receivables valued at ₪3.08b due within 12 months. So its liabilities total ₪10.0b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of ₪7.71b, we think shareholders really should watch Shikun & Binui's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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.
Shikun & Binui shareholders face the double whammy of a high net debt to EBITDA ratio (10.6), and fairly weak interest coverage, since EBIT is just 1.6 times the interest expense. This means we'd consider it to have a heavy debt load. More concerning, Shikun & Binui saw its EBIT drop by 8.1% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shikun & Binui'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Shikun & Binui actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
On the face of it, Shikun & Binui's interest cover left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. And even its level of total liabilities fails to inspire much confidence. After considering the datapoints discussed, we think Shikun & Binui has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For instance, we've identified 4 warning signs for Shikun & Binui (2 don't sit too well with us) 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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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.
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