Ari Real Estate (Arena) Investment (TLV:ARIN) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Ari Real Estate (Arena) Investment Ltd (TLV:ARIN) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Ari Real Estate (Arena) Investment

How Much Debt Does Ari Real Estate (Arena) Investment Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Ari Real Estate (Arena) Investment had ₪767.8m of debt, an increase on ₪596.6m, over one year. However, it does have ₪88.3m in cash offsetting this, leading to net debt of about ₪679.5m.

How Strong Is Ari Real Estate (Arena) Investment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ari Real Estate (Arena) Investment had liabilities of ₪136.7m due within 12 months and liabilities of ₪848.3m due beyond that. On the other hand, it had cash of ₪88.3m and ₪48.2m worth of receivables due within a year. So it has liabilities totalling ₪848.6m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₪796.5m, we think shareholders really should watch Ari Real Estate (Arena) Investment's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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

Ari Real Estate (Arena) Investment has a rather high debt to EBITDA ratio of 5.4 which suggests a meaningful debt load. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. The silver lining is that Ari Real Estate (Arena) Investment grew its EBIT by 228% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Ari Real Estate (Arena) Investment 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, Ari Real Estate (Arena) Investment's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Ari Real Estate (Arena) Investment's net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Ari Real Estate (Arena) Investment is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Ari Real Estate (Arena) Investment (1 is a bit concerning) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.