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.' 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 note that Ellomay Capital Ltd. (NYSEMKT:ELLO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Ellomay Capital's Net Debt?
As you can see below, at the end of September 2020, Ellomay Capital had €227.1m of debt, up from €201.8m a year ago. Click the image for more detail. However, it also had €62.7m in cash, and so its net debt is €164.4m.
How Healthy Is Ellomay Capital's Balance Sheet?
According to the last reported balance sheet, Ellomay Capital had liabilities of €29.4m due within 12 months, and liabilities of €239.1m due beyond 12 months. Offsetting this, it had €62.7m in cash and €7.23m in receivables that were due within 12 months. So it has liabilities totalling €198.5m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of €329.5m, so it does suggest shareholders should keep an eye on Ellomay Capital's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ellomay Capital'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.
Over 12 months, Ellomay Capital made a loss at the EBIT level, and saw its revenue drop to €10m, which is a fall of 47%. That makes us nervous, to say the least.
While Ellomay Capital's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost €6.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through €125m of cash over the last year. So in short it's a really risky stock. 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. For example, we've discovered 3 warning signs for Ellomay Capital (2 are a bit concerning!) that you should be aware of before investing here.
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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