We Think Alrov Properties and Lodgings (TLV:ALRPR) Is Taking Some Risk With Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Alrov Properties and Lodgings Ltd. (TLV:ALRPR) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Alrov Properties and Lodgings

How Much Debt Does Alrov Properties and Lodgings Carry?

The chart below, which you can click on for greater detail, shows that Alrov Properties and Lodgings had ₪7.90b in debt in September 2021; about the same as the year before. On the flip side, it has ₪982.6m in cash leading to net debt of about ₪6.91b.

A Look At Alrov Properties and Lodgings' Liabilities

According to the last reported balance sheet, Alrov Properties and Lodgings had liabilities of ₪1.94b due within 12 months, and liabilities of ₪7.45b due beyond 12 months. On the other hand, it had cash of ₪982.6m and ₪107.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪8.30b.

This deficit casts a shadow over the ₪4.47b company, like a colossus towering over mere mortals. 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.5 times and a disturbingly high net debt to EBITDA ratio of 15.6 hit our confidence in Alrov Properties and Lodgings like a one-two punch to the gut. The debt burden here is substantial. The good news is that Alrov Properties and Lodgings grew its EBIT a smooth 92% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Alrov Properties and Lodgings'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Alrov Properties and Lodgings recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Alrov Properties and Lodgings's level of total liabilities has us nervous. For example, its EBIT growth rate and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Alrov Properties and Lodgings'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Alrov Properties and Lodgings (2 can't be ignored!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.