These 4 Measures Indicate That Alony-Hetz Properties & Investments (TLV:ALHE) Is Using Debt In A Risky Way

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Alony-Hetz Properties & Investments Ltd (TLV:ALHE) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Alony-Hetz Properties & Investments

What Is Alony-Hetz Properties & Investments's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Alony-Hetz Properties & Investments had debt of ₪18.6b, up from ₪16.1b in one year. However, it also had ₪1.69b in cash, and so its net debt is ₪16.9b.

How Healthy Is Alony-Hetz Properties & Investments' Balance Sheet?

The latest balance sheet data shows that Alony-Hetz Properties & Investments had liabilities of ₪2.72b due within a year, and liabilities of ₪20.0b falling due after that. Offsetting these obligations, it had cash of ₪1.69b as well as receivables valued at ₪246.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪20.8b.

The deficiency here weighs heavily on the ₪4.89b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Alony-Hetz Properties & Investments would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 40.6 hit our confidence in Alony-Hetz Properties & Investments like a one-two punch to the gut. The debt burden here is substantial. Worse, Alony-Hetz Properties & Investments's EBIT was down 70% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Alony-Hetz Properties & Investments will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Alony-Hetz Properties & Investments saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Alony-Hetz Properties & Investments's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like Alony-Hetz Properties & Investments carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Alony-Hetz Properties & Investments (2 are a bit concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.