Zvi Sarfati & Sons Investments & Constructions (TLV:SRFT) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Zvi Sarfati & Sons Investments & Constructions Ltd. (TLV:SRFT) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zvi Sarfati & Sons Investments & Constructions

How Much Debt Does Zvi Sarfati & Sons Investments & Constructions Carry?

As you can see below, Zvi Sarfati & Sons Investments & Constructions had ₪455.9m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₪66.8m in cash offsetting this, leading to net debt of about ₪389.1m.

How Strong Is Zvi Sarfati & Sons Investments & Constructions' Balance Sheet?

According to the last reported balance sheet, Zvi Sarfati & Sons Investments & Constructions had liabilities of ₪543.4m due within 12 months, and liabilities of ₪76.3m due beyond 12 months. On the other hand, it had cash of ₪66.8m and ₪64.6m worth of receivables due within a year. So it has liabilities totalling ₪488.2m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₪435.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 11.4 hit our confidence in Zvi Sarfati & Sons Investments & Constructions like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Zvi Sarfati & Sons Investments & Constructions boosted its EBIT by a silky 42% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zvi Sarfati & Sons Investments & Constructions'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, 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, Zvi Sarfati & Sons Investments & Constructions recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Zvi Sarfati & Sons Investments & Constructions's conversion of EBIT to free cash flow left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that Zvi Sarfati & Sons Investments & Constructions's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Zvi Sarfati & Sons Investments & Constructions (including 1 which makes us a bit uncomfortable) .

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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