Here's Why Blue Square Real Estate (TLV:BLSR) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Blue Square Real Estate Ltd (TLV:BLSR) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Blue Square Real Estate

How Much Debt Does Blue Square Real Estate Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Blue Square Real Estate had ₪5.14b of debt, an increase on ₪4.47b, over one year. However, it does have ₪2.31b in cash offsetting this, leading to net debt of about ₪2.83b.

How Healthy Is Blue Square Real Estate's Balance Sheet?

We can see from the most recent balance sheet that Blue Square Real Estate had liabilities of ₪695.2m falling due within a year, and liabilities of ₪5.30b due beyond that. Offsetting these obligations, it had cash of ₪2.31b as well as receivables valued at ₪250.2m due within 12 months. So it has liabilities totalling ₪3.43b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₪3.24b, we think shareholders really should watch Blue Square Real Estate's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

Blue Square Real Estate has a rather high debt to EBITDA ratio of 9.7 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. Given the debt load, it's hardly ideal that Blue Square Real Estate's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Blue Square Real Estate'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Blue Square Real Estate recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Neither Blue Square Real Estate's ability handle its debt, based on its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Blue Square Real Estate'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 Blue Square Real Estate has 5 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.