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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, Caesarstone Ltd. (NASDAQ:CSTE) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Caesarstone's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Caesarstone had debt of US$23.5m, up from US$6.84m in one year. But on the other hand it also has US$122.4m in cash, leading to a US$98.9m net cash position.
A Look At Caesarstone's Liabilities
The latest balance sheet data shows that Caesarstone had liabilities of US$157.0m due within a year, and liabilities of US$168.9m falling due after that. On the other hand, it had cash of US$122.4m and US$111.3m worth of receivables due within a year. So it has liabilities totalling US$92.2m more than its cash and near-term receivables, combined.
Caesarstone has a market capitalization of US$455.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Caesarstone also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, Caesarstone's EBIT fell a jaw-dropping 23% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Caesarstone 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Caesarstone may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Caesarstone recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Caesarstone does have more liabilities than liquid assets, it also has net cash of US$98.9m. And it impressed us with free cash flow of US$28m, being 74% of its EBIT. So we don't have any problem with Caesarstone's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Caesarstone is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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