Tiv Taam Holdings 1 (TLV:TTAM) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Tiv Taam Holdings 1 Ltd. (TLV:TTAM) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tiv Taam Holdings 1

What Is Tiv Taam Holdings 1's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Tiv Taam Holdings 1 had debt of ₪29.7m, up from none in one year. On the flip side, it has ₪15.8m in cash leading to net debt of about ₪13.9m.

How Strong Is Tiv Taam Holdings 1's Balance Sheet?

We can see from the most recent balance sheet that Tiv Taam Holdings 1 had liabilities of ₪377.0m falling due within a year, and liabilities of ₪563.5m due beyond that. Offsetting these obligations, it had cash of ₪15.8m as well as receivables valued at ₪117.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪807.3m.

Given this deficit is actually higher than the company's market capitalization of ₪600.8m, we think shareholders really should watch Tiv Taam Holdings 1'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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt at just 0.095 times EBITDA, it seems Tiv Taam Holdings 1 only uses a little bit of leverage. Although with EBIT only covering interest expenses 3.7 times over, the company is truly paying for borrowing. Sadly, Tiv Taam Holdings 1's EBIT actually dropped 5.5% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tiv Taam Holdings 1'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 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, Tiv Taam Holdings 1 produced sturdy free cash flow equating to 78% 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 Tiv Taam Holdings 1's level of total liabilities has us nervous. For example, its net debt to EBITDA and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Tiv Taam Holdings 1's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 - Tiv Taam Holdings 1 has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.