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 Alony-Hetz Properties & Investments Ltd (TLV:ALHE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.
What Is Alony-Hetz Properties & Investments's Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Alony-Hetz Properties & Investments had debt of ₪14.3b, up from ₪13.3b in one year. On the flip side, it has ₪1.96b in cash leading to net debt of about ₪12.3b.
How Healthy Is Alony-Hetz Properties & Investments' Balance Sheet?
According to the last reported balance sheet, Alony-Hetz Properties & Investments had liabilities of ₪2.34b due within 12 months, and liabilities of ₪15.3b due beyond 12 months. On the other hand, it had cash of ₪1.96b and ₪363.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪15.3b.
This deficit casts a shadow over the ₪9.04b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Alony-Hetz Properties & Investments 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a net debt to EBITDA ratio of 10.8, it's fair to say Alony-Hetz Properties & Investments does have a significant amount of debt. However, its interest coverage of 2.9 is reasonably strong, which is a good sign. Even worse, Alony-Hetz Properties & Investments saw its EBIT tank 22% over the last 12 months. 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 it is Alony-Hetz Properties & Investments'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Alony-Hetz Properties & Investments burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, Alony-Hetz Properties & Investments'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. And furthermore, its net debt to EBITDA also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Alony-Hetz Properties & Investments is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Alony-Hetz Properties & Investments has 3 warning signs (and 1 which is significant) we think you should know about.
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.
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.
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