These 4 Measures Indicate That Dorsel (B.A.Z.) (TLV:DRSL) Is Using Debt Extensively

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.' 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 can see that Dorsel (B.A.Z.) Ltd (TLV:DRSL) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Dorsel (B.A.Z.)

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

As you can see below, at the end of September 2020, Dorsel (B.A.Z.) had ₪342.7m of debt, up from ₪306.4m a year ago. Click the image for more detail. However, it also had ₪106.1m in cash, and so its net debt is ₪236.6m.

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

The latest balance sheet data shows that Dorsel (B.A.Z.) had liabilities of ₪66.3m due within a year, and liabilities of ₪378.8m falling due after that. Offsetting this, it had ₪106.1m in cash and ₪5.46m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪333.6m.

When you consider that this deficiency exceeds the company's ₪280.3m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 6.1, it's fair to say Dorsel (B.A.Z.) does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.0 times, suggesting it can responsibly service its obligations. Given the debt load, it's hardly ideal that Dorsel (B.A.Z.)'s EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Dorsel (B.A.Z.) will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dorsel (B.A.Z.) produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Dorsel (B.A.Z.)'s net debt to EBITDA was disappointing. 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. For example, we've discovered 4 warning signs for Dorsel (B.A.Z.) (1 can't be ignored!) that you should be aware of before investing here.

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. 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.
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