Is Strauss Group (TLV:STRS) Using Too Much Debt?

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. As with many other companies Strauss Group Ltd. (TLV:STRS) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Strauss Group

What Is Strauss Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Strauss Group had ₪2.33b of debt, an increase on ₪2.20b, over one year. However, it also had ₪809.0m in cash, and so its net debt is ₪1.52b.

How Healthy Is Strauss Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Strauss Group had liabilities of ₪1.92b due within 12 months and liabilities of ₪2.46b due beyond that. On the other hand, it had cash of ₪809.0m and ₪1.20b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪2.38b.

This deficit isn't so bad because Strauss Group is worth ₪10.6b, 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 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).

Strauss Group's net debt of 1.8 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.2 times interest expense) certainly does not do anything to dispel this impression. One way Strauss Group could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 10%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is Strauss 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.

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 that EBIT is backed by free cash flow. During the last three years, Strauss Group produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Strauss Group's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And its interest cover is good too. Looking at all the aforementioned factors together, it strikes us that Strauss Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Strauss Group that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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