Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Aviv Arlon Ltd. (TLV:AVLN) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Aviv Arlon
How Much Debt Does Aviv Arlon Carry?
You can click the graphic below for the historical numbers, but it shows that Aviv Arlon had ₪19.7m of debt in June 2022, down from ₪22.3m, one year before. However, it does have ₪7.22m in cash offsetting this, leading to net debt of about ₪12.5m.
A Look At Aviv Arlon's Liabilities
Zooming in on the latest balance sheet data, we can see that Aviv Arlon had liabilities of ₪3.35m due within 12 months and liabilities of ₪39.7m due beyond that. Offsetting this, it had ₪7.22m in cash and ₪3.93m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪31.9m.
This is a mountain of leverage relative to its market capitalization of ₪39.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Aviv Arlon has net debt of just 1.3 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. Although Aviv Arlon made a loss at the EBIT level, last year, it was also good to see that it generated ₪9.4m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Aviv Arlon'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Aviv Arlon reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
Aviv Arlon's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Aviv Arlon's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 instance, we've identified 2 warning signs for Aviv Arlon (1 makes us a bit uncomfortable) you should be aware of.
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.
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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.
About TASE:CNGL
Canada Global (T.R)
Engages in the development, construction, improvement, leasing, management, and sale of real estate properties in the United States, Serbia, England, and Germany.
Flawless balance sheet low.