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 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. As with many other companies Rani Zim Shopping Centers Ltd (TLV:RANI) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Rani Zim Shopping Centers's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Rani Zim Shopping Centers had ₪727.0m of debt, an increase on ₪367.0m, over one year. However, it also had ₪25.2m in cash, and so its net debt is ₪701.8m.
How Strong Is Rani Zim Shopping Centers' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Rani Zim Shopping Centers had liabilities of ₪213.7m due within 12 months and liabilities of ₪656.5m due beyond that. Offsetting these obligations, it had cash of ₪25.2m as well as receivables valued at ₪15.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪829.2m.
Given this deficit is actually higher than the company's market capitalization of ₪694.7m, we think shareholders really should watch Rani Zim Shopping Centers's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Rani Zim Shopping Centers shareholders face the double whammy of a high net debt to EBITDA ratio (60.6), and fairly weak interest coverage, since EBIT is just 0.97 times the interest expense. The debt burden here is substantial. Even worse, Rani Zim Shopping Centers saw its EBIT tank 65% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Rani Zim Shopping Centers will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Rani Zim Shopping Centers produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
On the face of it, Rani Zim Shopping Centers's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Rani Zim Shopping Centers to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Rani Zim Shopping Centers (of which 1 can't be ignored!) you should know about.
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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