Is Shikun & Binui (TLV:SKBN) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shikun & Binui Ltd. (TLV:SKBN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shikun & Binui

How Much Debt Does Shikun & Binui Carry?

As you can see below, Shikun & Binui had ₪12.4b of debt at June 2024, down from ₪14.5b a year prior. However, it also had ₪3.27b in cash, and so its net debt is ₪9.13b.

How Strong Is Shikun & Binui's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shikun & Binui had liabilities of ₪12.9b due within 12 months and liabilities of ₪9.05b due beyond that. On the other hand, it had cash of ₪3.27b and ₪4.57b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪14.1b.

This deficit casts a shadow over the ₪4.69b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 18.6 hit our confidence in Shikun & Binui like a one-two punch to the gut. The debt burden here is substantial. Even worse, Shikun & Binui saw its EBIT tank 49% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shikun & Binui 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shikun & Binui saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Shikun & Binui's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Shikun & Binui is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 5 warning signs with Shikun & Binui (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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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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.