We Think Cofix Group (TLV:CFX) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Cofix Group Ltd (TLV:CFX) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Cofix Group

How Much Debt Does Cofix Group Carry?

As you can see below, at the end of December 2020, Cofix Group had ₪14.5m of debt, up from ₪2.64m a year ago. Click the image for more detail. However, its balance sheet shows it holds ₪19.2m in cash, so it actually has ₪4.67m net cash.

How Healthy Is Cofix Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cofix Group had liabilities of ₪82.6m due within 12 months and liabilities of ₪114.4m due beyond that. Offsetting these obligations, it had cash of ₪19.2m as well as receivables valued at ₪13.5m due within 12 months. So its liabilities total ₪164.3m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₪156.5m, we think shareholders really should watch Cofix Group'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. Cofix Group boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Notably, Cofix Group made a loss at the EBIT level, last year, but improved that to positive EBIT of ₪3.8m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cofix Group'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. While Cofix Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Cofix Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Cofix Group does have more liabilities than liquid assets, it also has net cash of ₪4.67m. And it impressed us with free cash flow of ₪24m, being 632% of its EBIT. So although we see some areas for improvement, we're not too worried about Cofix Group's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Cofix Group (1 shouldn't be ignored!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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