Is Y.Z. Queenco (TLV:QNCO) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Y.Z. Queenco Ltd. (TLV:QNCO) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Y.Z. Queenco

What Is Y.Z. Queenco's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Y.Z. Queenco had debt of ₪27.5m, up from ₪24.3m in one year. However, because it has a cash reserve of ₪18.0m, its net debt is less, at about ₪9.50m.

A Look At Y.Z. Queenco's Liabilities

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 total ₪64.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₪89.7m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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 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. Notably, Y.Z. Queenco made a loss at the EBIT level, last year, but improved that to positive EBIT of ₪6.4m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Y.Z. Queenco's earnings that will influence how the balance sheet holds up in the future. 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.

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 the earnings before interest and tax (EBIT) is backed by 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. On the other hand, its interest cover makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Y.Z. Queenco's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for Y.Z. Queenco you should be aware of, and 1 of them is significant.

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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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.