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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Bezeq The Israel Telecommunication Corp. Ltd (TLV:BEZQ) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Bezeq The Israel Telecommunication’s Debt?
The image below, which you can click on for greater detail, shows that Bezeq The Israel Telecommunication had debt of ₪8.40b at the end of March 2021, a reduction from ₪9.54b over a year. On the flip side, it has ₪1.79b in cash leading to net debt of about ₪6.61b.
How Healthy Is Bezeq The Israel Telecommunication’s Balance Sheet?
We can see from the most recent balance sheet that Bezeq The Israel Telecommunication had liabilities of ₪3.51b falling due within a year, and liabilities of ₪9.75b due beyond that. Offsetting these obligations, it had cash of ₪1.79b as well as receivables valued at ₪1.86b due within 12 months. So its liabilities total ₪9.62b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of ₪9.62b, so it does suggest shareholders should keep an eye on Bezeq The Israel Telecommunication’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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.
Bezeq The Israel Telecommunication’s net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 6.9 times last year. While that doesn’t worry us too much, it does suggest the interest payments are somewhat of a burden. We saw Bezeq The Israel Telecommunication grow its EBIT by 6.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Bezeq The Israel Telecommunication can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Bezeq The Israel Telecommunication generated free cash flow amounting to a very robust 92% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
When it comes to the balance sheet, the standout positive for Bezeq The Israel Telecommunication was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Bezeq The Israel Telecommunication’s use of debt. 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. These risks can be hard to spot. Every company has them, and we’ve spotted 2 warning signs for Bezeq The Israel Telecommunication you should know about.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.