Is American Realty Investors (NYSE:ARL) Using Debt Sensibly?

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.' 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 American Realty Investors, Inc. (NYSE:ARL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 American Realty Investors

How Much Debt Does American Realty Investors Carry?

You can click the graphic below for the historical numbers, but it shows that American Realty Investors had US$432.8m of debt in March 2021, down from US$468.8m, one year before. However, it does have US$53.9m in cash offsetting this, leading to net debt of about US$379.0m.

How Healthy Is American Realty Investors' Balance Sheet?

We can see from the most recent balance sheet that American Realty Investors had liabilities of US$26.9m falling due within a year, and liabilities of US$442.6m due beyond that. On the other hand, it had cash of US$53.9m and US$126.8m worth of receivables due within a year. So it has liabilities totalling US$288.8m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$136.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, American Realty Investors would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is American Realty Investors'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.

Over 12 months, American Realty Investors reported revenue of US$57m, which is a gain of 24%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate American Realty Investors's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at US$255k. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of US$14m and the profit of US$24m. So there is definitely a chance that it can improve things in the next few years. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for American Realty Investors (of which 1 makes us a bit uncomfortable!) 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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