Is Hod Assaf Industries (TLV:HOD) 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.' 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 Hod Assaf Industries Ltd. (TLV:HOD) makes use of debt. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Hod Assaf Industries

What Is Hod Assaf Industries's Net Debt?

The image below, which you can click on for greater detail, shows that Hod Assaf Industries had debt of ₪233.4m at the end of December 2020, a reduction from ₪366.4m over a year. However, it does have ₪13.8m in cash offsetting this, leading to net debt of about ₪219.6m.

How Healthy Is Hod Assaf Industries' Balance Sheet?

The latest balance sheet data shows that Hod Assaf Industries had liabilities of ₪422.2m due within a year, and liabilities of ₪44.7m falling due after that. Offsetting these obligations, it had cash of ₪13.8m as well as receivables valued at ₪314.5m due within 12 months. So it has liabilities totalling ₪138.6m more than its cash and near-term receivables, combined.

Hod Assaf Industries has a market capitalization of ₪305.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hod Assaf Industries's debt is 3.4 times its EBITDA, and its EBIT cover its interest expense 4.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, the silver lining was that Hod Assaf Industries achieved a positive EBIT of ₪31m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hod Assaf Industries 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Hod Assaf Industries actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On our analysis Hod Assaf Industries's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. Looking at all this data makes us feel a little cautious about Hod Assaf Industries's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. For instance, we've identified 2 warning signs for Hod Assaf Industries that you should be aware of.

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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