Alrov Properties and Lodgings (TLV:ALRPR) Use Of Debt Could Be Considered Risky

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Alrov Properties and Lodgings Ltd. (TLV:ALRPR) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Alrov Properties and Lodgings

What Is Alrov Properties and Lodgings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Alrov Properties and Lodgings had ₪8.35b of debt, an increase on ₪7.25b, over one year. On the flip side, it has ₪897.4m in cash leading to net debt of about ₪7.45b.

A Look At Alrov Properties and Lodgings' Liabilities

Zooming in on the latest balance sheet data, we can see that Alrov Properties and Lodgings had liabilities of ₪2.14b due within 12 months and liabilities of ₪8.40b due beyond that. Offsetting these obligations, it had cash of ₪897.4m as well as receivables valued at ₪170.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪9.48b.

The deficiency here weighs heavily on the ₪2.94b 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'd watch its balance sheet closely, without a doubt. After all, Alrov Properties and Lodgings 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Alrov Properties and Lodgings shareholders face the double whammy of a high net debt to EBITDA ratio (15.3), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. Given the debt load, it's hardly ideal that Alrov Properties and Lodgings's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Alrov Properties and Lodgings's earnings that will influence how the balance sheet holds up in the future. 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. During the last three years, Alrov Properties and Lodgings produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Alrov Properties and Lodgings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider Alrov Properties and Lodgings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should be aware of the 2 warning signs we've spotted with Alrov Properties and Lodgings .

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.