Adika Style (TLV:ADKA) Has Debt But No Earnings; Should You Worry?

By
Simply Wall St
Published
September 14, 2021
TASE:ADKA
Source: Shutterstock

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 Adika Style Ltd. (TLV:ADKA) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Adika Style

What Is Adika Style's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Adika Style had debt of ₪10.0m, up from ₪7.89m in one year. However, its balance sheet shows it holds ₪17.2m in cash, so it actually has ₪7.21m net cash.

debt-equity-history-analysis
TASE:ADKA Debt to Equity History September 14th 2021

A Look At Adika Style's Liabilities

The latest balance sheet data shows that Adika Style had liabilities of ₪60.3m due within a year, and liabilities of ₪71.2m falling due after that. Offsetting this, it had ₪17.2m in cash and ₪15.8m in receivables that were due within 12 months. So its liabilities total ₪98.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₪142.8m, so it does suggest shareholders should keep an eye on Adika Style's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Adika Style boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Adika Style'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.

Over 12 months, Adika Style reported revenue of ₪227m, which is a gain of 32%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Adika Style?

While Adika Style lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow ₪12m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that Adika Style is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Adika Style (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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