Does Shikun & Binui (TLV:SKBN) Have A Healthy Balance Sheet?

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.' 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 Shikun & Binui Ltd. (TLV:SKBN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shikun & Binui

What Is Shikun & Binui's Net Debt?

As you can see below, at the end of December 2022, Shikun & Binui had ₪12.7b of debt, up from ₪11.0b a year ago. Click the image for more detail. On the flip side, it has ₪4.19b in cash leading to net debt of about ₪8.52b.

How Healthy Is Shikun & Binui's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shikun & Binui had liabilities of ₪12.1b due within 12 months and liabilities of ₪9.16b due beyond that. Offsetting these obligations, it had cash of ₪4.19b as well as receivables valued at ₪3.68b due within 12 months. So it has liabilities totalling ₪13.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₪2.89b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Shikun & Binui would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 (10.8), and fairly weak interest coverage, since EBIT is just 0.67 times the interest expense. This means we'd consider it to have a heavy debt load. Fortunately, Shikun & Binui grew its EBIT by 9.2% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Shikun & Binui'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, Shikun & Binui's free cash flow amounted to 22% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Shikun & Binui's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Shikun & Binui has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. Case in point: We've spotted 4 warning signs for Shikun & Binui you should be aware of, and 2 of them are 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.