Is Hagag Group Real Estate Entrepreneurship (TLV:HGG) Using Too Much 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hagag Group Real Estate Entrepreneurship Ltd (TLV:HGG) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hagag Group Real Estate Entrepreneurship

What Is Hagag Group Real Estate Entrepreneurship's Net Debt?

As you can see below, at the end of September 2020, Hagag Group Real Estate Entrepreneurship had ₪774.4m of debt, up from ₪615.2m a year ago. Click the image for more detail. On the flip side, it has ₪103.4m in cash leading to net debt of about ₪671.0m.

How Strong Is Hagag Group Real Estate Entrepreneurship's Balance Sheet?

According to the last reported balance sheet, Hagag Group Real Estate Entrepreneurship had liabilities of ₪739.8m due within 12 months, and liabilities of ₪269.8m due beyond 12 months. On the other hand, it had cash of ₪103.4m and ₪108.0m worth of receivables due within a year. So it has liabilities totalling ₪798.2m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₪893.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). 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).

Hagag Group Real Estate Entrepreneurship has a rather high debt to EBITDA ratio of 13.2 which suggests a meaningful debt load. However, its interest coverage of 4.0 is reasonably strong, which is a good sign. Even more troubling is the fact that Hagag Group Real Estate Entrepreneurship actually let its EBIT decrease by 2.5% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Hagag Group Real Estate Entrepreneurship'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Hagag Group Real Estate Entrepreneurship saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Hagag Group Real Estate Entrepreneurship's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Hagag Group Real Estate Entrepreneurship's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 4 warning signs for Hagag Group Real Estate Entrepreneurship you should be aware of, and 1 of them makes us a bit uncomfortable.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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