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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Y.H. Dimri Construction & Development's Net Debt?
The chart below, which you can click on for greater detail, shows that Y.H. Dimri Construction & Development had ₪2.39b in debt in September 2021; about the same as the year before. However, it does have ₪167.7m in cash offsetting this, leading to net debt of about ₪2.22b.
A Look At Y.H. Dimri Construction & Development's Liabilities
We can see from the most recent balance sheet that Y.H. Dimri Construction & Development had liabilities of ₪968.8m falling due within a year, and liabilities of ₪1.88b due beyond that. On the other hand, it had cash of ₪167.7m and ₪353.3m worth of receivables due within a year. So its liabilities total ₪2.32b more than the combination of its cash and short-term receivables.
Y.H. Dimri Construction & Development has a market capitalization of ₪5.95b, 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Y.H. Dimri Construction & Development has a rather high debt to EBITDA ratio of 6.5 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 5.5 times, suggesting it can responsibly service its obligations. Importantly, Y.H. Dimri Construction & Development grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Y.H. Dimri Construction & Development's earnings that will influence how the balance sheet holds up in the future. 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. Over the last three years, Y.H. Dimri Construction & Development saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Y.H. Dimri Construction & Development's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Y.H. Dimri Construction & Development's debt poses some risks to the business. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Y.H. Dimri Construction & Development is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.