Is Gold Bond Group (TLV:GOLD) Using Too Much 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 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. Importantly, The Gold Bond Group Ltd. (TLV:GOLD) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Gold Bond Group

What Is Gold Bond Group's Debt?

As you can see below, at the end of September 2020, Gold Bond Group had ₪92.1m of debt, up from ₪55.8m a year ago. Click the image for more detail. However, it also had ₪79.1m in cash, and so its net debt is ₪13.1m.

A Look At Gold Bond Group's Liabilities

According to the last reported balance sheet, Gold Bond Group had liabilities of ₪53.7m due within 12 months, and liabilities of ₪182.4m due beyond 12 months. Offsetting these obligations, it had cash of ₪79.1m as well as receivables valued at ₪45.3m due within 12 months. So it has liabilities totalling ₪111.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Gold Bond Group has a market capitalization of ₪458.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Gold Bond Group has a very low debt to EBITDA ratio of 0.54 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Gold Bond Group's EBIT fell a jaw-dropping 67% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Gold Bond 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Gold Bond Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Gold Bond Group's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. It's also worth noting that Gold Bond Group is in the Infrastructure industry, which is often considered to be quite defensive. Looking at the bigger picture, it seems clear to us that Gold Bond Group's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Gold Bond Group (including 1 which is is concerning) .

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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