Here's Why Dorsel (B.A.Z.) (TLV:DRSL) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Dorsel (B.A.Z.) Ltd (TLV:DRSL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dorsel (B.A.Z.)

What Is Dorsel (B.A.Z.)'s Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Dorsel (B.A.Z.) had debt of ₪470.7m, up from ₪313.0m in one year. On the flip side, it has ₪103.9m in cash leading to net debt of about ₪366.9m.

How Strong Is Dorsel (B.A.Z.)'s Balance Sheet?

We can see from the most recent balance sheet that Dorsel (B.A.Z.) had liabilities of ₪73.8m falling due within a year, and liabilities of ₪519.9m due beyond that. Offsetting these obligations, it had cash of ₪103.9m as well as receivables valued at ₪5.53m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪484.3m.

This deficit casts a shadow over the ₪300.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Dorsel (B.A.Z.) would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

With a net debt to EBITDA ratio of 8.1, it's fair to say Dorsel (B.A.Z.) does have a significant amount of debt. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. On a slightly more positive note, Dorsel (B.A.Z.) grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dorsel (B.A.Z.)'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Dorsel (B.A.Z.) recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Dorsel (B.A.Z.)'s net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Dorsel (B.A.Z.)'s use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. Be aware that Dorsel (B.A.Z.) is showing 5 warning signs in our investment analysis , and 1 of those is potentially serious...

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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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.