Is Gav-Yam Lands (TLV:GVYM) A Risky Investment?

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 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gav-Yam Lands

What Is Gav-Yam Lands's Debt?

As you can see below, at the end of March 2021, Gav-Yam Lands had ₪5.78b of debt, up from ₪5.42b a year ago. Click the image for more detail. On the flip side, it has ₪1.40b in cash leading to net debt of about ₪4.38b.

How Healthy Is Gav-Yam Lands' Balance Sheet?

We can see from the most recent balance sheet that Gav-Yam Lands had liabilities of ₪979.2m falling due within a year, and liabilities of ₪6.33b due beyond that. On the other hand, it had cash of ₪1.40b and ₪109.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪5.80b.

This deficit is considerable relative to its market capitalization of ₪6.55b, so it does suggest shareholders should keep an eye on Gav-Yam Lands' use of debt. 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). 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).

Gav-Yam Lands has a rather high debt to EBITDA ratio of 9.1 which suggests a meaningful debt load. However, its interest coverage of 3.3 is reasonably strong, which is a good sign. Notably, Gav-Yam Lands's EBIT was pretty flat over the last year, which isn't ideal given the debt load. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gav-Yam Lands will need earnings to service that debt. 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 83% 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

Neither Gav-Yam Lands's ability handle its debt, based on its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that Gav-Yam Lands is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Gav-Yam Lands (including 1 which is significant) .

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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