Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Strauss Group Ltd. (TLV:STRS) is in debt. But should shareholders worry about its use of debt?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Discover our latest analysis for Strauss Group
How much debt does the Strauss Group carry?
You can click on the graph below for historical figures, but it shows that in June 2022 Strauss Group had debt of ₪2.18 billion, an increase from ₪1.98 billion, on a year. On the other hand, it has ₪441.0 million in cash, resulting in a net debt of around ₪1.74 billion.
A look at the liabilities of the Strauss Group
We can see from the most recent balance sheet that the Strauss Group had liabilities of ₪2.31 billion due within a year, and liabilities of ₪2.26 billion due beyond that. On the other hand, it had a cash position of ₪441.0 million and ₪1.14 billion in receivables within one year. Thus, its liabilities total ₪2.99 billion more than the combination of its cash and short-term receivables.
This shortfall is not that bad as the Strauss Group is worth £9.99bn and could therefore probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
The Strauss Group has a net debt to EBITDA ratio of 2.7, suggesting it uses a bit of leverage to boost returns. On the positive side, its EBIT was 9.0 times its interest expense, and its net debt to EBITDA ratio was quite high, at 2.7. Shareholders should know that Strauss Group’s EBIT fell 48% last year. If this earnings trend continues, paying off debt will be about as easy as herding cats on a roller coaster. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine the Strauss Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, the Strauss Group has produced strong free cash flow equivalent to 68% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
The Strauss Group’s struggle to increase EBIT made us doubt the strength of its balance sheet, but the other data points we considered were relatively rewarding. For example, its conversion of EBIT to free cash flow was refreshing. From all the angles mentioned above, it seems to us that Strauss Group is a bit risky investment because of its debt. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 3 warning signs for Strauss Group which you should be aware of before investing here.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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