Electra Consumer Products (1970) (TLV:ECP) Seems To Use Debt Quite Sensibly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Electra Consumer Products (1970) Ltd (TLV:ECP) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Electra Consumer Products (1970)

How Much Debt Does Electra Consumer Products (1970) Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Electra Consumer Products (1970) had debt of ₪565.2m, up from ₪115.2m in one year. However, because it has a cash reserve of ₪370.4m, its net debt is less, at about ₪194.8m.

How Strong Is Electra Consumer Products (1970)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Electra Consumer Products (1970) had liabilities of ₪2.41b due within 12 months and liabilities of ₪2.28b due beyond that. On the other hand, it had cash of ₪370.4m and ₪658.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪3.66b.

Given this deficit is actually higher than the company's market capitalization of ₪3.41b, we think shareholders really should watch Electra Consumer Products (1970)'s debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). 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 0.58 and interest cover of 5.7 times, it seems to us that Electra Consumer Products (1970) 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. Pleasingly, Electra Consumer Products (1970) is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 2,339% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Electra Consumer Products (1970)'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Electra Consumer Products (1970) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Electra Consumer Products (1970)'s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its level of total liabilities. All these things considered, it appears that Electra Consumer Products (1970) can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that Electra Consumer Products (1970) is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.