Lodzia Real Estate (TLV:LODZ) Use Of Debt Could Be Considered Risky

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Lodzia Real Estate Ltd. (TLV:LODZ) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lodzia Real Estate

What Is Lodzia Real Estate's Debt?

As you can see below, at the end of June 2024, Lodzia Real Estate had ₪172.0m of debt, up from ₪145.4m a year ago. Click the image for more detail. However, it also had ₪11.5m in cash, and so its net debt is ₪160.5m.

How Healthy Is Lodzia Real Estate's Balance Sheet?

The latest balance sheet data shows that Lodzia Real Estate had liabilities of ₪27.3m due within a year, and liabilities of ₪200.6m falling due after that. On the other hand, it had cash of ₪11.5m and ₪8.59m worth of receivables due within a year. So it has liabilities totalling ₪207.8m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₪95.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Lodzia Real Estate would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.37 times and a disturbingly high net debt to EBITDA ratio of 23.7 hit our confidence in Lodzia Real Estate like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The silver lining is that Lodzia Real Estate grew its EBIT by 234% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lodzia Real Estate'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Lodzia Real Estate recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Lodzia Real Estate's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Lodzia Real Estate 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. 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. We've identified 5 warning signs with Lodzia Real Estate (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.