These 4 Measures Indicate That Alrov Properties and Lodgings (TLV:ALRPR) Is Using Debt In A Risky Way

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 note that Alrov Properties and Lodgings Ltd. (TLV:ALRPR) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alrov Properties and Lodgings

How Much Debt Does Alrov Properties and Lodgings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Alrov Properties and Lodgings had ₪7.78b of debt, an increase on ₪7.01b, over one year. On the flip side, it has ₪462.0m in cash leading to net debt of about ₪7.32b.

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 ₪2.11b falling due within a year, and liabilities of ₪7.24b due beyond that. On the other hand, it had cash of ₪462.0m and ₪109.4m worth of receivables due within a year. So its liabilities total ₪8.78b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₪2.92b 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.85 times and a disturbingly high net debt to EBITDA ratio of 24.5 hit our confidence in Alrov Properties and Lodgings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Alrov Properties and Lodgings saw its EBIT tank 26% 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. There's no doubt that we learn most about debt from the balance sheet. But it is Alrov Properties and Lodgings'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 always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Alrov Properties and Lodgings recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We think the chances that Alrov Properties and Lodgings has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Alrov Properties and Lodgings 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.

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