Computer Direct Group (TLV:CMDR) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Computer Direct Group Ltd. (TLV:CMDR) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Computer Direct Group

How Much Debt Does Computer Direct Group Carry?

As you can see below, Computer Direct Group had ₪224.4m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₪119.2m in cash leading to net debt of about ₪105.2m.

How Strong Is Computer Direct Group's Balance Sheet?

According to the last reported balance sheet, Computer Direct Group had liabilities of ₪587.3m due within 12 months, and liabilities of ₪268.6m due beyond 12 months. On the other hand, it had cash of ₪119.2m and ₪544.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪191.8m.

While this might seem like a lot, it is not so bad since Computer Direct Group has a market capitalization of ₪757.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Computer Direct Group has a low net debt to EBITDA ratio of only 0.65. And its EBIT covers its interest expense a whopping 71.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Computer Direct Group grew its EBIT by 2.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Computer Direct Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Computer Direct Group generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Computer Direct Group's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Computer Direct Group seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Computer Direct Group you should be aware of, and 1 of them is a bit unpleasant.

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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