Does Alrov Properties and Lodgings (TLV:ALRPR) Have A Healthy Balance Sheet?

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.' 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 note that Alrov Properties and Lodgings Ltd. (TLV:ALRPR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Alrov Properties and Lodgings

How Much Debt Does Alrov Properties and Lodgings Carry?

The chart below, which you can click on for greater detail, shows that Alrov Properties and Lodgings had ₪7.26b in debt in December 2022; about the same as the year before. However, it does have ₪940.1m in cash offsetting this, leading to net debt of about ₪6.32b.

How Healthy Is Alrov Properties and Lodgings' Balance Sheet?

We can see from the most recent balance sheet that Alrov Properties and Lodgings had liabilities of ₪1.36b falling due within a year, and liabilities of ₪7.93b due beyond that. Offsetting this, it had ₪940.1m in cash and ₪72.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪8.27b.

This deficit casts a shadow over the ₪3.37b company, like a colossus towering over mere mortals. 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 13.4, it's fair to say Alrov Properties and Lodgings does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 2.8 times, suggesting it can responsibly service its obligations. Worse, Alrov Properties and Lodgings's EBIT was down 22% 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 Alrov Properties and Lodgings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Alrov Properties and Lodgings produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Alrov Properties and Lodgings's EBIT growth rate 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. Taking into account all the aforementioned factors, it looks like Alrov Properties and Lodgings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Alrov Properties and Lodgings (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.