Shikun & Binui (TLV:SKBN) Has No Shortage Of Debt

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 Shikun & Binui Ltd. (TLV:SKBN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shikun & Binui

What Is Shikun & Binui's Net Debt?

The chart below, which you can click on for greater detail, shows that Shikun & Binui had ₪8.65b in debt in September 2020; about the same as the year before. However, it also had ₪2.46b in cash, and so its net debt is ₪6.19b.

A Look At Shikun & Binui's Liabilities

We can see from the most recent balance sheet that Shikun & Binui had liabilities of ₪5.84b falling due within a year, and liabilities of ₪7.11b due beyond that. Offsetting this, it had ₪2.46b in cash and ₪3.16b in receivables that were due within 12 months. So its liabilities total ₪7.33b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₪8.58b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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 has a rather high debt to EBITDA ratio of 9.9 which suggests a meaningful debt load. However, its interest coverage of 4.0 is reasonably strong, which is a good sign. Even worse, Shikun & Binui saw its EBIT tank 24% 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shikun & Binui burned a lot of cash. 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

On the face of it, Shikun & Binui's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill 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. 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. Be aware that Shikun & Binui is showing 3 warning signs in our investment analysis , and 2 of those can't be ignored...

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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