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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shapir Engineering and Industry Ltd (TLV:SPEN) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Shapir Engineering and Industry

How Much Debt Does Shapir Engineering and Industry Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Shapir Engineering and Industry had ₪6.88b of debt, an increase on ₪4.32b, over one year. However, it does have ₪749.6m in cash offsetting this, leading to net debt of about ₪6.13b.

A Look At Shapir Engineering and Industry's Liabilities

According to the last reported balance sheet, Shapir Engineering and Industry had liabilities of ₪2.97b due within 12 months, and liabilities of ₪6.28b due beyond 12 months. Offsetting this, it had ₪749.6m in cash and ₪1.84b in receivables that were due within 12 months. So its liabilities total ₪6.67b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₪10.3b. 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.

Shapir Engineering and Industry shareholders face the double whammy of a high net debt to EBITDA ratio (9.6), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. The debt burden here is substantial. Another concern for investors might be that Shapir Engineering and Industry's EBIT fell 18% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is Shapir Engineering and Industry's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Shapir Engineering and Industry created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Shapir Engineering and Industry's EBIT growth rate left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shapir Engineering and Industry (of which 1 shouldn't be ignored!) you should know about.

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.