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.' 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 can see that AFI Properties Ltd (TLV:AFPR) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for AFI Properties
How Much Debt Does AFI Properties Carry?
As you can see below, at the end of March 2021, AFI Properties had ₪7.89b of debt, up from ₪5.89b a year ago. Click the image for more detail. However, it does have ₪468.6m in cash offsetting this, leading to net debt of about ₪7.42b.
A Look At AFI Properties' Liabilities
The latest balance sheet data shows that AFI Properties had liabilities of ₪1.84b due within a year, and liabilities of ₪7.50b falling due after that. Offsetting this, it had ₪468.6m in cash and ₪294.1m in receivables that were due within 12 months. So its liabilities total ₪8.58b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the ₪5.04b 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. At the end of the day, AFI Properties would probably need a major re-capitalization if its creditors were to demand repayment.
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.
With a net debt to EBITDA ratio of 17.1, it's fair to say AFI Properties does have a significant amount of debt. However, its interest coverage of 4.8 is reasonably strong, which is a good sign. We note that AFI Properties grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is AFI Properties's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept 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, AFI Properties produced sturdy free cash flow equating to 75% 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
Both AFI Properties's level of total liabilities and its net debt to EBITDA were discouraging. But at least its conversion of EBIT to free cash flow is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think AFI Properties's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 5 warning signs with AFI Properties (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. 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.
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About TASE:AFPR
Proven track record very low.
