We Think Computer Direct Group (TLV:CMDR) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Computer Direct Group Ltd. (TLV:CMDR) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Computer Direct Group

How Much Debt Does Computer Direct Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Computer Direct Group had ₪427.9m of debt, an increase on ₪298.2m, over one year. However, because it has a cash reserve of ₪264.6m, its net debt is less, at about ₪163.4m.

How Strong Is Computer Direct Group's Balance Sheet?

According to the last reported balance sheet, Computer Direct Group had liabilities of ₪917.1m due within 12 months, and liabilities of ₪540.5m due beyond 12 months. Offsetting these obligations, it had cash of ₪264.6m as well as receivables valued at ₪736.3m due within 12 months. So it has liabilities totalling ₪456.7m more than its cash and near-term receivables, combined.

Computer Direct Group has a market capitalization of ₪926.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Computer Direct Group's net debt is only 0.85 times its EBITDA. And its EBIT easily covers its interest expense, being 19.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Computer Direct Group has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Computer Direct Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Computer Direct Group's use of debt seems quite reasonable and we're not concerned about it. 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. For example, we've discovered 2 warning signs for Computer Direct Group that you should be aware of before investing here.

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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