Is Isramco Negev 2 Limited Partnership (TLV:ISRA.L) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Isramco Negev 2 Limited Partnership (TLV:ISRA.L) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Isramco Negev 2 Limited Partnership

How Much Debt Does Isramco Negev 2 Limited Partnership Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Isramco Negev 2 Limited Partnership had US$618.2m of debt, an increase on US$548.7m, over one year. However, it does have US$243.0m in cash offsetting this, leading to net debt of about US$375.2m.

How Healthy Is Isramco Negev 2 Limited Partnership's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Isramco Negev 2 Limited Partnership had liabilities of US$313.4m due within 12 months and liabilities of US$568.0m due beyond that. Offsetting these obligations, it had cash of US$243.0m as well as receivables valued at US$51.0m due within 12 months. So its liabilities total US$587.3m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$620.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Isramco Negev 2 Limited Partnership's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 11.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Isramco Negev 2 Limited Partnership's saving grace is its low debt levels, because its EBIT has tanked 31% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Isramco Negev 2 Limited Partnership will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Isramco Negev 2 Limited Partnership actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While Isramco Negev 2 Limited Partnership's EBIT growth rate has us nervous. To wit both its conversion of EBIT to free cash flow and interest cover were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Isramco Negev 2 Limited Partnership is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. We've identified 2 warning signs with Isramco Negev 2 Limited Partnership , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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