Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Caesarstone Ltd. (NASDAQ:CSTE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Caesarstone's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Caesarstone had US$19.1m of debt in March 2022, down from US$23.8m, one year before. However, it does have US$58.1m in cash offsetting this, leading to net cash of US$39.0m.
How Healthy Is Caesarstone's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Caesarstone had liabilities of US$169.6m due within 12 months and liabilities of US$181.1m due beyond that. On the other hand, it had cash of US$58.1m and US$126.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$165.9m.
This deficit isn't so bad because Caesarstone is worth US$325.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Caesarstone boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Caesarstone's EBIT was down 26% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Caesarstone's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept 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. Looking at the most recent three years, Caesarstone recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
Although Caesarstone's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$39.0m. Despite the cash, we do find Caesarstone's EBIT growth rate concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Caesarstone is showing 1 warning sign in our investment analysis , 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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