Here's Why Delta Galil Industries (TLV:DELG) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Delta Galil Industries Ltd. (TLV:DELG) 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?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Delta Galil Industries

How Much Debt Does Delta Galil Industries Carry?

The chart below, which you can click on for greater detail, shows that Delta Galil Industries had US$399.2m in debt in March 2023; about the same as the year before. However, because it has a cash reserve of US$181.4m, its net debt is less, at about US$217.7m.

A Look At Delta Galil Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Delta Galil Industries had liabilities of US$568.5m due within 12 months and liabilities of US$531.9m due beyond that. On the other hand, it had cash of US$181.4m and US$247.5m worth of receivables due within a year. So it has liabilities totalling US$671.4m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$1.08b, so it does suggest shareholders should keep an eye on Delta Galil Industries' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Looking at its net debt to EBITDA of 0.84 and interest cover of 5.2 times, it seems to us that Delta Galil Industries is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. The bad news is that Delta Galil Industries saw its EBIT decline by 11% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Delta Galil Industries 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, Delta Galil Industries produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Delta Galil Industries's EBIT growth rate does give us pause, its conversion of EBIT to free cash flow and net debt to EBITDA suggest it can stay on top of its debt load. Looking at all the angles mentioned above, it does seem to us that Delta Galil Industries is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Delta Galil Industries has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.