Here's Why Arad Investment & Industrial Development (TLV:ARAD) Can Manage Its Debt Responsibly

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.' 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 can see that Arad Investment & Industrial Development Ltd. (TLV:ARAD) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Arad Investment & Industrial Development

How Much Debt Does Arad Investment & Industrial Development Carry?

The image below, which you can click on for greater detail, shows that Arad Investment & Industrial Development had debt of ₪687.9m at the end of March 2024, a reduction from ₪4.10b over a year. However, it does have ₪381.0m in cash offsetting this, leading to net debt of about ₪306.9m.

A Look At Arad Investment & Industrial Development's Liabilities

According to the last reported balance sheet, Arad Investment & Industrial Development had liabilities of ₪1.08b due within 12 months, and liabilities of ₪737.4m due beyond 12 months. Offsetting these obligations, it had cash of ₪381.0m as well as receivables valued at ₪1.01b due within 12 months. So it has liabilities totalling ₪427.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₪602.2m, so it does suggest shareholders should keep an eye on Arad Investment & Industrial 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.

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).

Arad Investment & Industrial Development has a very low debt to EBITDA ratio of 1.4 so it is strange to see weak interest coverage, with last year's EBIT being only 2.1 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Arad Investment & Industrial Development is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 553% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Arad Investment & Industrial Development's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Arad Investment & Industrial Development actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Arad Investment & Industrial Development's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Arad Investment & Industrial Development can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Arad Investment & Industrial Development that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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