Is Primotec Group (TLV:PRMG) Using Too Much 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.' 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. We can see that Primotec Group Ltd (TLV:PRMG) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Primotec Group

How Much Debt Does Primotec Group Carry?

The image below, which you can click on for greater detail, shows that Primotec Group had debt of ₪30.3m at the end of June 2024, a reduction from ₪101.7m over a year. But it also has ₪30.7m in cash to offset that, meaning it has ₪415.0k net cash.

How Strong Is Primotec Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Primotec Group had liabilities of ₪69.4m due within 12 months and liabilities of ₪14.6m due beyond that. On the other hand, it had cash of ₪30.7m and ₪73.9m worth of receivables due within a year. So it can boast ₪20.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Primotec Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Primotec Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Primotec Group grew its EBIT by 188% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Primotec Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Primotec Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Primotec Group's free cash flow amounted to 23% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Primotec Group has net cash of ₪415.0k, as well as more liquid assets than liabilities. And we liked the look of last year's 188% year-on-year EBIT growth. So is Primotec Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Primotec Group has 2 warning signs we think you should be aware of.

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.