These 4 Measures Indicate That Shapir Engineering and Industry (TLV:SPEN) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shapir Engineering and Industry Ltd (TLV:SPEN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shapir Engineering and Industry

What Is Shapir Engineering and Industry's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Shapir Engineering and Industry had ₪6.43b of debt, an increase on ₪4.48b, over one year. However, it also had ₪692.5m in cash, and so its net debt is ₪5.74b.

How Strong Is Shapir Engineering and Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shapir Engineering and Industry had liabilities of ₪2.41b due within 12 months and liabilities of ₪6.40b due beyond that. Offsetting these obligations, it had cash of ₪692.5m as well as receivables valued at ₪1.76b due within 12 months. So it has liabilities totalling ₪6.36b more than its cash and near-term receivables, combined.

Shapir Engineering and Industry has a market capitalization of ₪10.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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 2.0 times and a disturbingly high net debt to EBITDA ratio of 8.9 hit our confidence in Shapir Engineering and Industry like a one-two punch to the gut. The debt burden here is substantial. More concerning, Shapir Engineering and Industry saw its EBIT drop by 9.0% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shapir Engineering and Industry 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shapir Engineering and Industry reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Shapir Engineering and Industry's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. And even its EBIT growth rate fails to inspire much confidence. Overall, it seems to us that Shapir Engineering and Industry's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 instance, we've identified 2 warning signs for Shapir Engineering and Industry (1 makes us a bit uncomfortable) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.