Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Electra Real Estate Ltd. (TLV:ELCRE) is in debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Discover our latest analysis for Electra Real Estate
What is Electra Real Estate’s net debt?
As you can see below, at the end of September 2021, Electra Real Estate had a debt of ₪672.7 million, compared to ₪434.8 million a year ago. Click on the image for more details. On the other hand, he has ₪96.5 million in cash, resulting in a net debt of around ₪576.2 million.
How healthy is Electra Real Estate’s balance sheet?
We can see from the most recent balance sheet that Electra Real Estate had liabilities of ₪256.5 million due within one year, and liabilities of ₪648.5 million due beyond. In return, he had £96.5 million in cash and £54.6 million in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (short-term) by ₪753.9 million.
While that might sound like a lot, it’s not that bad since Electra Real Estate has a market capitalization of ₪3.76 billion, so it could probably strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
We would say that Electra Real Estate’s moderate net debt to EBITDA ratio (1.5) indicates prudence in terms of leverage. And its towering EBIT of 13.8 times its interest expense means that the debt burden is as light as a peacock feather. What is even more impressive is that Electra Real Estate has increased its EBIT by 200% in twelve months. This boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Electra Real Estate that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Electra Real Estate has generated free cash flow amounting to 10% of its EBIT, an uninspiring performance. For us, such a low cash conversion creates a bit of paranoia about the ability to extinguish the debt.
Our point of view
The good news is that Electra Real Estate’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But the harsh truth is that we are concerned about its conversion from EBIT to free cash flow. All in all, it looks like Electra Real Estate can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Electra Real Estate (2 of which are significant!) that you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.