These 4 Measures Indicate That Naphtha Israel Petroleum (TLV:NFTA) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Naphtha Israel Petroleum Corp. Ltd. (TLV:NFTA) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Naphtha Israel Petroleum

What Is Naphtha Israel Petroleum's Debt?

As you can see below, Naphtha Israel Petroleum had ₪2.18b of debt at September 2020, down from ₪3.11b a year prior. However, it does have ₪541.8m in cash offsetting this, leading to net debt of about ₪1.64b.

How Healthy Is Naphtha Israel Petroleum's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Naphtha Israel Petroleum had liabilities of ₪617.9m due within 12 months and liabilities of ₪2.20b due beyond that. Offsetting this, it had ₪541.8m in cash and ₪374.0m in receivables that were due within 12 months. So its liabilities total ₪1.90b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₪1.38b, we think shareholders really should watch Naphtha Israel Petroleum'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 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.

Naphtha Israel Petroleum has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 51.4 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Naphtha Israel Petroleum has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Naphtha Israel Petroleum 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Naphtha Israel Petroleum actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Naphtha Israel Petroleum's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Naphtha Israel Petroleum is taking some risks with its use of debt. 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. To that end, you should be aware of the 2 warning signs we've spotted with Naphtha Israel Petroleum .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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