Here's Why Y.Z. Queenco (TLV:QNCO) Can Manage Its Debt Responsibly

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. As with many other companies Y.Z. Queenco Ltd. (TLV:QNCO) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Y.Z. Queenco

What Is Y.Z. Queenco's Debt?

As you can see below, at the end of June 2022, Y.Z. Queenco had ₪27.5m of debt, up from ₪24.3m a year ago. Click the image for more detail. However, it does have ₪18.0m in cash offsetting this, leading to net debt of about ₪9.50m.

How Strong Is Y.Z. Queenco's Balance Sheet?

According to the last reported balance sheet, Y.Z. Queenco had liabilities of ₪37.7m due within 12 months, and liabilities of ₪47.3m due beyond 12 months. Offsetting this, it had ₪18.0m in cash and ₪2.24m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪64.7m.

This deficit isn't so bad because Y.Z. Queenco is worth ₪120.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Y.Z. Queenco's low debt to EBITDA ratio of 0.54 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that Y.Z. Queenco improved its EBIT from a last year's loss to a positive ₪6.4m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Y.Z. Queenco will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Y.Z. Queenco recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Y.Z. Queenco's net debt to EBITDA was a real positive on this analysis, as was its conversion of EBIT to free cash flow. Having said that, its interest cover somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the factors mentioned above, we do feel a bit cautious about Y.Z. Queenco's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Y.Z. Queenco (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.