David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Alrov Properties and Lodgings Ltd. (TLV: ALRPR) has debt on its balance sheet. But the most important question is: what risk does this debt create?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

See our latest review for Alrov Properties and Lodgings

What is the net debt of Alrov Properties and Lodgings?

As you can see below, at the end of June 2021, Alrov Properties and Lodgings had a debt of 8.06 billion yen, up from 7.58 billion yen a year ago. Click on the image for more details. However, given that it has a cash reserve of 802.1 million yen, its net debt is less, at around 7.26 billion yen.

How healthy is Alrov Properties and Lodgings’ balance sheet?

The latest balance sheet data shows that Alrov Properties and Lodgings had liabilities of 2.04 billion yen due within one year, and liabilities of 7.50 billion yen due after that. On the other hand, it had cash of 802.1 million and 108.0 million in receivables due within one year. Thus, its liabilities exceed the sum of its cash and its (short-term) receivables by 8.64.

The lack here weighs heavily on society ₪ 4.45b itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment, and a trumpet. We therefore believe that shareholders should watch it closely. After all, Alrov Properties and Lodgings would likely need a major recapitalization if it were to pay its creditors today.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Alrov Properties and Lodgings shareholders are faced with the double whammy of a high net debt / EBITDA ratio (20.3) and relatively low interest coverage, since EBIT is only 2.3 times the interest charges. The debt burden here is considerable. On the other hand, Alrov Properties and Lodgings increased its EBIT by 26% last year. If sustained, this growth should cause this debt to evaporate like scarce drinking water during an unusually hot summer. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since Alrov Properties and Lodgings will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

Finally, a business can only repay its debts with hard cash, not with book profits. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Alrov Properties and Lodgings has generated strong free cash flow equivalent to 62% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.

Our point of view

At first glance, Alrov Properties and Lodgings’ net debt to EBITDA left us hesitant about the stock, and its total liability level was no more appealing than the single empty restaurant on the busiest night of the year. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that Alrov Properties and Lodgings’ use of debt creates risks for the business. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 4 warning signs for Alrov properties and dwellings you need to be aware, and 2 of them are potentially serious.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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

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