Is Lahav LR Real Estate (TLV:LAHAV) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Lahav LR Real Estate Ltd (TLV:LAHAV) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Lahav LR Real Estate

What Is Lahav LR Real Estate's Net Debt?

As you can see below, at the end of September 2020, Lahav LR Real Estate had ₪165.7m of debt, up from ₪142.0m a year ago. Click the image for more detail. On the flip side, it has ₪99.4m in cash leading to net debt of about ₪66.3m.

How Strong Is Lahav LR Real Estate's Balance Sheet?

We can see from the most recent balance sheet that Lahav LR Real Estate had liabilities of ₪15.1m falling due within a year, and liabilities of ₪179.7m due beyond that. Offsetting these obligations, it had cash of ₪99.4m as well as receivables valued at ₪2.73m due within 12 months. So its liabilities total ₪92.7m more than the combination of its cash and short-term receivables.

Of course, Lahav LR Real Estate has a market capitalization of ₪638.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Lahav LR Real Estate has a low debt to EBITDA ratio of only 1.4. 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. In addition to that, we're happy to report that Lahav LR Real Estate has boosted its EBIT by 95%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lahav LR 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Lahav LR Real Estate burned a lot of cash. 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

Based on what we've seen Lahav LR Real Estate is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Lahav LR Real Estate is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 3 warning signs for Lahav LR Real Estate (2 are concerning!) 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.

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