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

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 note that Electra Consumer Products (1970) Ltd (TLV:ECP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Electra Consumer Products (1970)

What Is Electra Consumer Products (1970)'s Debt?

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.

A Look At Electra Consumer Products (1970)'s Liabilities

We can see from the most recent balance sheet that Electra Consumer Products (1970) had liabilities of ₪2.41b falling due within a year, and liabilities of ₪2.28b due beyond that. Offsetting this, it had ₪370.4m in cash and ₪658.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪3.66b.

This deficit is considerable relative to its market capitalization of ₪4.11b, so it does suggest shareholders should keep an eye on Electra Consumer Products (1970)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Electra Consumer Products (1970)'s low debt to EBITDA ratio of 0.67 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Electra Consumer Products (1970)'s EBIT launched higher than Elon Musk, gaining a whopping 1,850% on last year. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Electra Consumer Products (1970) actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Electra Consumer Products (1970)'s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Electra Consumer Products (1970) can handle its debt fairly comfortably. 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. 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. For example Electra Consumer Products (1970) has 3 warning signs (and 1 which makes us a bit uncomfortable) we think 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.