Is Top Ramdor Systems & Computers (1990) (TLV:TOPS) Using Too Much 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.' 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. We note that Top Ramdor Systems & Computers Co. (1990) Ltd (TLV:TOPS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Top Ramdor Systems & Computers (1990)

What Is Top Ramdor Systems & Computers (1990)'s Debt?

As you can see below, at the end of December 2020, Top Ramdor Systems & Computers (1990) had ₪26.5m of debt, up from ₪18.7m a year ago. Click the image for more detail. However, it does have ₪19.1m in cash offsetting this, leading to net debt of about ₪7.42m.

How Strong Is Top Ramdor Systems & Computers (1990)'s Balance Sheet?

According to the last reported balance sheet, Top Ramdor Systems & Computers (1990) had liabilities of ₪64.8m due within 12 months, and liabilities of ₪29.0m due beyond 12 months. On the other hand, it had cash of ₪19.1m and ₪56.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪17.8m.

Of course, Top Ramdor Systems & Computers (1990) has a market capitalization of ₪196.3m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.54 times EBITDA, Top Ramdor Systems & Computers (1990) is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 9.4 times the interest expense over the last year. On top of that, Top Ramdor Systems & Computers (1990) grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Top Ramdor Systems & Computers (1990)'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Top Ramdor Systems & Computers (1990) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Top Ramdor Systems & Computers (1990)'s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Top Ramdor Systems & Computers (1990) is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. For instance, we've identified 4 warning signs for Top Ramdor Systems & Computers (1990) that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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