We Think Prashkovsky Investments and Construction (TLV:PRSK) Is Taking Some Risk With Its 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Prashkovsky Investments and Construction Ltd. (TLV:PRSK) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Prashkovsky Investments and Construction

What Is Prashkovsky Investments and Construction's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Prashkovsky Investments and Construction had debt of ₪1.79b, up from ₪1.14b in one year. However, because it has a cash reserve of ₪632.5m, its net debt is less, at about ₪1.16b.

How Healthy Is Prashkovsky Investments and Construction's Balance Sheet?

The latest balance sheet data shows that Prashkovsky Investments and Construction had liabilities of ₪1.92b due within a year, and liabilities of ₪572.8m falling due after that. Offsetting these obligations, it had cash of ₪632.5m as well as receivables valued at ₪401.6m due within 12 months. So its liabilities total ₪1.46b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₪1.77b, so it does suggest shareholders should keep an eye on Prashkovsky Investments and Construction's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Prashkovsky Investments and Construction's net debt is 3.5 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 14.0 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. It is well worth noting that Prashkovsky Investments and Construction's EBIT shot up like bamboo after rain, gaining 41% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Prashkovsky Investments and Construction'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Prashkovsky Investments and Construction reported free cash flow worth 8.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Prashkovsky Investments and Construction's conversion of EBIT to free cash flow does give us pause, its interest cover and EBIT growth rate suggest it can stay on top of its debt load. We think that Prashkovsky Investments and Construction's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 5 warning signs for Prashkovsky Investments and Construction (2 are significant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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