Gav-Yam Lands (TLV:GVYM) Takes On Some Risk With Its Use Of Debt

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.' 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 Gav-Yam Lands Corp. Ltd (TLV:GVYM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Gav-Yam Lands

How Much Debt Does Gav-Yam Lands Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Gav-Yam Lands had ₪5.48b of debt, an increase on ₪5.04b, over one year. However, because it has a cash reserve of ₪418.0m, its net debt is less, at about ₪5.06b.

A Look At Gav-Yam Lands' Liabilities

We can see from the most recent balance sheet that Gav-Yam Lands had liabilities of ₪874.0m falling due within a year, and liabilities of ₪6.21b due beyond that. Offsetting this, it had ₪418.0m in cash and ₪77.4m in receivables that were due within 12 months. So it has liabilities totalling ₪6.59b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₪7.30b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Gav-Yam Lands has a rather high debt to EBITDA ratio of 10.2 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. The good news is that Gav-Yam Lands improved its EBIT by 2.5% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Gav-Yam Lands'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Gav-Yam Lands recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Gav-Yam Lands's net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Gav-Yam Lands'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Gav-Yam Lands (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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