Polygon Real Estate (TLV:POLY) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Polygon Real Estate Ltd (TLV:POLY) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, 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.

Check out our latest analysis for Polygon Real Estate

What Is Polygon Real Estate's Debt?

You can click the graphic below for the historical numbers, but it shows that Polygon Real Estate had ₪13.4m of debt in December 2020, down from ₪16.7m, one year before. However, because it has a cash reserve of ₪9.32m, its net debt is less, at about ₪4.09m.

How Healthy Is Polygon Real Estate's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Polygon Real Estate had liabilities of ₪9.31m due within 12 months and liabilities of ₪7.05m due beyond that. Offsetting this, it had ₪9.32m in cash and ₪3.70m in receivables that were due within 12 months. So its liabilities total ₪3.34m more than the combination of its cash and short-term receivables.

Given Polygon Real Estate has a market capitalization of ₪146.4m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). 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).

Polygon Real Estate's net debt is only 0.26 times its EBITDA. And its EBIT covers its interest expense a whopping 33.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Polygon Real Estate has increased its EBIT by 3.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Polygon Real Estate 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 it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Polygon Real Estate actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Polygon Real Estate's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Polygon Real Estate's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. Be aware that Polygon Real Estate is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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