We Think Castro Model (TLV:CAST) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Castro Model Ltd. (TLV:CAST) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Castro Model

How Much Debt Does Castro Model Carry?

The image below, which you can click on for greater detail, shows that Castro Model had debt of ₪273.8m at the end of September 2020, a reduction from ₪305.3m over a year. However, its balance sheet shows it holds ₪319.6m in cash, so it actually has ₪45.8m net cash.

A Look At Castro Model's Liabilities

The latest balance sheet data shows that Castro Model had liabilities of ₪439.7m due within a year, and liabilities of ₪1.05b falling due after that. On the other hand, it had cash of ₪319.6m and ₪26.1m worth of receivables due within a year. So it has liabilities totalling ₪1.14b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₪383.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Castro Model would likely require a major re-capitalisation if it had to pay its creditors today. Castro Model boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

We also note that Castro Model improved its EBIT from a last year's loss to a positive ₪75m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Castro Model will need earnings to service that debt. 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. While Castro Model has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Castro Model actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Castro Model does have more liabilities than liquid assets, it also has net cash of ₪45.8m. And it impressed us with free cash flow of ₪169m, being 227% of its EBIT. Despite its cash we think that Castro Model seems to struggle to handle its total liabilities, so we are wary of the stock. 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. Case in point: We've spotted 3 warning signs for Castro Model you should be aware of, and 2 of them make us uncomfortable.

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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