These 4 Measures Indicate That Amos Luzon Development and Energy Group (TLV:LUZN) Is Using Debt Extensively

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 note that Amos Luzon Development and Energy Group Ltd (TLV:LUZN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Amos Luzon Development and Energy Group

How Much Debt Does Amos Luzon Development and Energy Group Carry?

The image below, which you can click on for greater detail, shows that Amos Luzon Development and Energy Group had debt of ₪622.0m at the end of March 2021, a reduction from ₪686.1m over a year. On the flip side, it has ₪286.4m in cash leading to net debt of about ₪335.7m.

How Strong Is Amos Luzon Development and Energy Group's Balance Sheet?

According to the last reported balance sheet, Amos Luzon Development and Energy Group had liabilities of ₪656.3m due within 12 months, and liabilities of ₪472.9m due beyond 12 months. On the other hand, it had cash of ₪286.4m and ₪221.2m worth of receivables due within a year. So its liabilities total ₪621.6m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₪509.1m, we think shareholders really should watch Amos Luzon Development and Energy Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Amos Luzon Development and Energy Group has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 3.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Amos Luzon Development and Energy Group grew its EBIT at 13% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Amos Luzon Development and Energy Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Amos Luzon Development and Energy Group recorded free cash flow worth 67% 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.

Our View

Both Amos Luzon Development and Energy Group's level of total liabilities and its net debt to EBITDA were discouraging. But at least its conversion of EBIT to free cash flow is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think Amos Luzon Development and Energy Group's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Amos Luzon Development and Energy Group is showing 4 warning signs in our investment analysis , you should know about...

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.

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