Z.M.H Hammerman (TLV:ZMH) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Z.M.H Hammerman Ltd (TLV:ZMH) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Z.M.H Hammerman

What Is Z.M.H Hammerman's Debt?

The image below, which you can click on for greater detail, shows that Z.M.H Hammerman had debt of ₪460.0m at the end of December 2020, a reduction from ₪540.9m over a year. However, it also had ₪188.2m in cash, and so its net debt is ₪271.8m.

How Healthy Is Z.M.H Hammerman's Balance Sheet?

We can see from the most recent balance sheet that Z.M.H Hammerman had liabilities of ₪406.4m falling due within a year, and liabilities of ₪201.3m due beyond that. On the other hand, it had cash of ₪188.2m and ₪74.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪344.9m.

This is a mountain of leverage relative to its market capitalization of ₪501.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Z.M.H Hammerman has a debt to EBITDA ratio of 4.1 and its EBIT covered its interest expense 4.1 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. More concerning, Z.M.H Hammerman saw its EBIT drop by 3.5% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Z.M.H Hammerman'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Z.M.H Hammerman recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Z.M.H Hammerman's level of total liabilities 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 its EBIT growth rate is not so bad. Once we consider all the factors above, together, it seems to us that Z.M.H Hammerman's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 2 warning signs for Z.M.H Hammerman you should be aware of.

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.

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