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

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 Alrov Properties and Lodgings Ltd. (TLV:ALRPR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Alrov Properties and Lodgings

What Is Alrov Properties and Lodgings's Net Debt?

As you can see below, Alrov Properties and Lodgings had ₪7.93b of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₪572.6m in cash offsetting this, leading to net debt of about ₪7.36b.

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 ₪2.06b falling due within a year, and liabilities of ₪7.43b due beyond that. Offsetting this, it had ₪572.6m in cash and ₪143.4m in receivables that were due within 12 months. So its liabilities total ₪8.77b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₪3.68b 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, Alrov Properties and Lodgings 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 25.4 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. Worse, Alrov Properties and Lodgings's EBIT was down 39% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Alrov Properties and Lodgings 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. Looking at the most recent three years, Alrov Properties and Lodgings recorded free cash flow of 48% 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. After considering the datapoints discussed, we think Alrov Properties and Lodgings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example Alrov Properties and Lodgings has 3 warning signs (and 2 which are potentially serious) we think you should know about.

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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