Here’s why Discount Investments (TLV:DISI) is weighed down by debt burden

Legendary fund manager Li Lu (backed by Charlie Munger) once said, “The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.” So when you think about the risk of a particular stock, it might be obvious that you need to consider debt. Because too much debt can sink a company. the important thing is, Discount Investment Corporation (TLV:DISI) has debt. But should shareholders be worried about its use of debt?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it is at their mercy. If the situation gets too bad, lenders may take control of your business. But a more common (but still expensive) situation is when a company needs to dilute shareholders at a cheap share price just to manage its debt. However, as an alternative to dilution, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis on Discount Investing.

What is Discount Investment’s net debt?

As you can see below, Discount Investment’s debt was ₪17.3b at September 2023, down from ₪1.80b in the same period a year ago. However, since the company has cash of ₪2.88b, its net debt is less, at around ₪14.4b.

How healthy is Discount Investment’s balance sheet?

According to its last reported balance sheet, Discount Investment had liabilities of ₪6.97b due within 12 months, and liabilities of ₪16.3b due beyond 12 months. . Offsetting this, it had cash of ¥2.88 billion and receivables due within 12 months of ¥1.14 billion. So it has liabilities of ₪19.3b more than its cash and short-term receivables, combined.

This deficit casts a shadow over the ₪546.7 million company like a colossus towering over mere mortals. So we definitely think shareholders need to monitor this closely. After all, if creditors demand repayment, Discount Investment will likely need a major recapitalization.

We look at net debt divided by earnings before interest, tax, depreciation and amortization (EBITDA) and calculate how easily a company’s earnings before interest, tax, depreciation and amortization (EBIT) cover interest. Measure your debt load. Expenses (interest burden). Therefore, we consider debt relative to earnings, with or without depreciation.

Weak interest cover of 1.7x and disturbingly high net debt to EBITDA ratio of 11.9 shattered our faith in discount investing like a one-two punch to the gut. This means that you are likely to be in a lot of debt. To make matters worse, Discount Investment’s EBIT was down 41% year over year. If earnings continue on this trajectory, paying down that debt will be harder than convincing someone to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious place to start. But it’s the returns from discount investments that will influence how the balance sheet holds up in the future. So when considering debt, it’s worth keeping an eye on the earnings trend. Click here to view an interactive snapshot.

But final considerations are also important. This is because companies cannot pay their debts with paper profits. I need cold cash. So we always check how much of that EBIT is converted into free cash flow. Fortunately for shareholders, over the past three years Discount His Investments actually generated free cash flow that exceeded his EBIT. There’s nothing better than having cash coming in to stay in the good graces of lenders.

our view

On the surface, we’re hesitant about this stock given Discount Investment’s EBIT growth rate, and its total debt level is comparable to an empty restaurant on the busiest night of the year. It wasn’t that attractive. But at least it’s pretty decent at converting EBIT to free cash flow. That’s encouraging. It’s clear that we think discount investing is quite risky given the strength of our balance sheet. In short, we’re as wary of this stock as we are of a hungry kitten falling into its owner’s fish pond. As the saying goes, once bitten, twice shy. There’s no question that we learn most about debt from the balance sheet. Ultimately, however, any company can contain risks that exist outside the balance sheet. For example, we discovered that 1 warning sign for discount investing What you need to know before investing here.

If you’re interested in investing in a business that allows you to grow profits without taking on debt, check this out free A list of growing companies that have net cash on their balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodologies, and the articles are not intended as financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.