These 4 Measures Indicate That Y.H. Dimri Construction & Development (TLV:DIMRI) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Y.H. Dimri Construction & Development Ltd (TLV:DIMRI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Y.H. Dimri Construction & Development

What Is Y.H. Dimri Construction & Development's Net Debt?

As you can see below, at the end of September 2020, Y.H. Dimri Construction & Development had ₪2.30b of debt, up from ₪1.74b a year ago. Click the image for more detail. However, because it has a cash reserve of ₪92.5m, its net debt is less, at about ₪2.21b.

How Healthy Is Y.H. Dimri Construction & Development's Balance Sheet?

According to the last reported balance sheet, Y.H. Dimri Construction & Development had liabilities of ₪956.5m due within 12 months, and liabilities of ₪1.76b due beyond 12 months. Offsetting these obligations, it had cash of ₪92.5m as well as receivables valued at ₪454.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪2.17b.

This deficit is considerable relative to its market capitalization of ₪2.81b, so it does suggest shareholders should keep an eye on Y.H. Dimri Construction & Development's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

With a net debt to EBITDA ratio of 9.1, it's fair to say Y.H. Dimri Construction & Development does have a significant amount of debt. However, its interest coverage of 4.5 is reasonably strong, which is a good sign. If Y.H. Dimri Construction & Development can keep growing EBIT at last year's rate of 13% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But it is Y.H. Dimri Construction & Development'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Y.H. Dimri Construction & Development saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Y.H. Dimri Construction & Development's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Y.H. Dimri Construction & Development has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 1 warning sign with Y.H. Dimri Construction & Development , and understanding them should be part of your investment process.

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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