Here's Why Delta Galil Industries (TLV:DELT) Can Manage Its Debt Responsibly

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:DELT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Delta Galil Industries

What Is Delta Galil Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Delta Galil Industries had US$392.6m of debt in June 2022, down from US$425.3m, one year before. On the flip side, it has US$177.3m in cash leading to net debt of about US$215.3m.

How Strong Is Delta Galil Industries' Balance Sheet?

We can see from the most recent balance sheet that Delta Galil Industries had liabilities of US$552.0m falling due within a year, and liabilities of US$617.1m due beyond that. Offsetting this, it had US$177.3m in cash and US$192.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$799.5m.

This deficit is considerable relative to its market capitalization of US$1.27b, so it does suggest shareholders should keep an eye on Delta Galil Industries' use of debt. 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.

While Delta Galil Industries's low debt to EBITDA ratio of 0.76 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.4 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Another good sign is that Delta Galil Industries has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Delta Galil Industries'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Delta Galil Industries generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Delta Galil Industries's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Delta Galil Industries is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Delta Galil Industries is showing 2 warning signs in our investment analysis , you should know about...

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.