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.' 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, Orian Sh.M. Ltd. (TLV:ORIN) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
View our latest analysis for Orian Sh.M
What Is Orian Sh.M's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Orian Sh.M had debt of US$61.0m, up from US$51.7m in one year. However, it does have US$29.0m in cash offsetting this, leading to net debt of about US$32.0m.
How Strong Is Orian Sh.M's Balance Sheet?
The latest balance sheet data shows that Orian Sh.M had liabilities of US$75.8m due within a year, and liabilities of US$149.5m falling due after that. On the other hand, it had cash of US$29.0m and US$73.5m worth of receivables due within a year. So it has liabilities totalling US$122.9m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$203.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
We'd say that Orian Sh.M's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 11.8 times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Orian Sh.M is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 222% gain in the last twelve months. 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 Orian Sh.M 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, Orian Sh.M burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Orian Sh.M's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about Orian Sh.M's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 4 warning signs for Orian Sh.M (2 make us uncomfortable!) that you should be aware of before investing here.
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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About TASE:ORIN
Good value with acceptable track record.