Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Formula Systems (1985) Ltd. (TLV:FORTY) uses debt in its business. But should shareholders worry about its use of debt?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest review for Formula Systems (1985)
What is the debt of Formula Systems (1985)?
The image below, which you can click on for more details, shows that in September 2021, Formula Systems (1985) had a debt of $628.5 million, compared to $552.3 million in one year . On the other hand, he has $495.1 million in cash, resulting in a net debt of around $133.4 million.
A Look at the Liabilities of Formula Systems (1985)
The latest balance sheet data shows that Formula Systems (1985) had liabilities of $861.6 million due within the year, and liabilities of $622.2 million due thereafter. On the other hand, it had cash of 495.1 million dollars and 686.3 million dollars in receivables within one year. Thus, its liabilities total $302.3 million more than the combination of its cash and short-term receivables.
Given that publicly traded shares of Formula Systems (1985) are worth a total of US$1.72 billion, it seems unlikely that this level of liability poses a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
The net debt of Formula Systems (1985) is only 0.51 times its EBITDA. And its EBIT easily covers its interest charges, which is 11.6 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. And we also note warmly that Formula Systems (1985) increased its EBIT by 20% last year, making its debt more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Formula Systems (1985) will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Formula Systems (1985) has had free cash flow of 75% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
The good news is that Formula Systems’ (1985) demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we think Formula Systems’ (1985) use of debt seems quite reasonable and we are not concerned about that. After all, reasonable leverage can increase return on equity. Above most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you’ve also achieved this achievement, you’re in luck, because today you can view this interactive historical earnings per share chart from Formula Systems (1985) for free.
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.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.
Comments are closed.