Is Shikun & Binui (TLV:SKBN) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Shikun & Binui Ltd. (TLV:SKBN) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shikun & Binui

How Much Debt Does Shikun & Binui Carry?

The chart below, which you can click on for greater detail, shows that Shikun & Binui had ₪12.1b in debt in March 2023; about the same as the year before. On the flip side, it has ₪3.11b in cash leading to net debt of about ₪9.03b.

How Healthy Is Shikun & Binui's Balance Sheet?

The latest balance sheet data shows that Shikun & Binui had liabilities of ₪11.5b due within a year, and liabilities of ₪9.30b falling due after that. Offsetting this, it had ₪3.11b in cash and ₪4.08b in receivables that were due within 12 months. So it has liabilities totalling ₪13.6b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₪4.06b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Shikun & Binui would probably need a major re-capitalization if its creditors were to demand repayment.

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

Shikun & Binui shareholders face the double whammy of a high net debt to EBITDA ratio (11.1), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. The good news is that Shikun & Binui improved its EBIT by 6.0% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shikun & Binui will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Shikun & Binui burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Shikun & Binui's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like 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. For example, we've discovered 6 warning signs for Shikun & Binui (2 are concerning!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.