We Think Shagrir Group Vehicle Services (TLV:SHGR) Can Stay On Top Of Its Debt

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.' 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. As with many other companies Shagrir Group Vehicle Services Ltd (TLV:SHGR) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shagrir Group Vehicle Services

What Is Shagrir Group Vehicle Services's Debt?

As you can see below, at the end of June 2020, Shagrir Group Vehicle Services had ₪38.1m of debt, up from ₪29.8m a year ago. Click the image for more detail. However, it does have ₪19.9m in cash offsetting this, leading to net debt of about ₪18.2m.

How Healthy Is Shagrir Group Vehicle Services's Balance Sheet?

According to the last reported balance sheet, Shagrir Group Vehicle Services had liabilities of ₪95.1m due within 12 months, and liabilities of ₪60.2m due beyond 12 months. Offsetting these obligations, it had cash of ₪19.9m as well as receivables valued at ₪54.9m due within 12 months. So its liabilities total ₪80.5m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₪114.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.78 and interest cover of 2.9 times, it seems to us that Shagrir Group Vehicle Services is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Shagrir Group Vehicle Services is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 2,345% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Shagrir Group Vehicle Services's earnings that will influence how the balance sheet holds up in the future. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Shagrir Group Vehicle Services's free cash flow amounted to 25% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Shagrir Group Vehicle Services was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Shagrir Group Vehicle Services's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 2 warning signs for Shagrir Group Vehicle Services you should be aware of, and 1 of them doesn't sit too well with us.

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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