Here's Why Isramco Negev 2 Limited Partnership (TLV:ISRA) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Isramco Negev 2 Limited Partnership (TLV:ISRA) does carry debt. But the real question is whether this debt is making the company risky.

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Isramco Negev 2 Limited Partnership

What Is Isramco Negev 2 Limited Partnership's Debt?

The image below, which you can click on for greater detail, shows that Isramco Negev 2 Limited Partnership had debt of US$456.7m at the end of June 2022, a reduction from US$565.8m over a year. However, because it has a cash reserve of US$78.5m, its net debt is less, at about US$378.2m.

A Look At Isramco Negev 2 Limited Partnership's Liabilities

According to the last reported balance sheet, Isramco Negev 2 Limited Partnership had liabilities of US$154.6m due within 12 months, and liabilities of US$579.9m due beyond 12 months. Offsetting this, it had US$78.5m in cash and US$60.5m in receivables that were due within 12 months. So it has liabilities totalling US$595.6m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$960.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Isramco Negev 2 Limited Partnership has net debt of just 1.5 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.4 times the interest expense over the last year. But the other side of the story is that Isramco Negev 2 Limited Partnership saw its EBIT decline by 6.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into 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

When it comes to the balance sheet, the standout positive for Isramco Negev 2 Limited Partnership was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For example, its EBIT growth rate makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Isramco Negev 2 Limited Partnership is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Isramco Negev 2 Limited Partnership you should be aware of, and 1 of them shouldn't be ignored.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.