Electra Consumer Products (1970) (TLV:ECP) Use Of Debt Could Be Considered Risky

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.' 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. Importantly, Electra Consumer Products (1970) Ltd (TLV:ECP) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Electra Consumer Products (1970)

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

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Electra Consumer Products (1970) had ₪1.43b of debt, an increase on ₪925.5m, over one year. However, it does have ₪409.9m in cash offsetting this, leading to net debt of about ₪1.02b.

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

The latest balance sheet data shows that Electra Consumer Products (1970) had liabilities of ₪3.10b due within a year, and liabilities of ₪2.91b falling due after that. On the other hand, it had cash of ₪409.9m and ₪827.3m worth of receivables due within a year. So it has liabilities totalling ₪4.77b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₪1.36b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Electra Consumer Products (1970) would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.41 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Electra Consumer Products (1970) like a one-two punch to the gut. The debt burden here is substantial. Worse, Electra Consumer Products (1970)'s EBIT was down 67% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Electra Consumer Products (1970) burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Electra Consumer Products (1970)'s EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Electra Consumer Products (1970) is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. To that end, you should learn about the 4 warning signs we've spotted with Electra Consumer Products (1970) (including 2 which can't be ignored) .

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.