Does Kardan Real Estate Enterprise and Development (TLV:KARE) Have A Healthy Balance Sheet?

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. As with many other companies Kardan Real Estate Enterprise and Development Ltd. (TLV:KARE) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Kardan Real Estate Enterprise and Development

What Is Kardan Real Estate Enterprise and Development's Debt?

The image below, which you can click on for greater detail, shows that at March 2020 Kardan Real Estate Enterprise and Development had debt of ₪390.4m, up from ₪261.9m in one year. However, because it has a cash reserve of ₪378.2m, its net debt is less, at about ₪12.2m.

How Strong Is Kardan Real Estate Enterprise and Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kardan Real Estate Enterprise and Development had liabilities of ₪363.5m due within 12 months and liabilities of ₪322.2m due beyond that. Offsetting these obligations, it had cash of ₪378.2m as well as receivables valued at ₪84.7m due within 12 months. So its liabilities total ₪222.8m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₪340.2m, so it does suggest shareholders should keep an eye on Kardan Real Estate Enterprise and Development's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Given net debt is only 0.30 times EBITDA, it is initially surprising to see that Kardan Real Estate Enterprise and Development's EBIT has low interest coverage of 2.3 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Unfortunately, Kardan Real Estate Enterprise and Development's EBIT flopped 15% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kardan Real Estate Enterprise and Development will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Kardan Real Estate Enterprise and Development's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Kardan Real Estate Enterprise and Development's EBIT growth rate left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Kardan Real Estate Enterprise and Development's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 example, we've discovered 5 warning signs for Kardan Real Estate Enterprise and Development (1 is a bit concerning!) that you should be aware of before investing here.

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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