Is Mivne Real Estate (K.D) (TLV:MVNE) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Mivne Real Estate (K.D) Ltd (TLV:MVNE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Mivne Real Estate (K.D)

What Is Mivne Real Estate (K.D)'s Net Debt?

As you can see below, Mivne Real Estate (K.D) had ₪5.38b of debt at December 2020, down from ₪5.93b a year prior. However, it does have ₪455.8m in cash offsetting this, leading to net debt of about ₪4.93b.

A Look At Mivne Real Estate (K.D)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Mivne Real Estate (K.D) had liabilities of ₪971.5m due within 12 months and liabilities of ₪6.05b due beyond that. Offsetting this, it had ₪455.8m in cash and ₪198.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪6.37b.

This is a mountain of leverage relative to its market capitalization of ₪8.01b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mivne Real Estate (K.D) has a rather high debt to EBITDA ratio of 8.2 which suggests a meaningful debt load. However, its interest coverage of 3.8 is reasonably strong, which is a good sign. Another concern for investors might be that Mivne Real Estate (K.D)'s EBIT fell 12% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mivne Real Estate (K.D) 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Mivne Real Estate (K.D) produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Mivne Real Estate (K.D)'s net debt to EBITDA was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Mivne Real Estate (K.D) has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Mivne Real Estate (K.D) you should be aware of, and 1 of them shouldn't be ignored.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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