Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Electra Real Estate Ltd. (TLV:ELCRE) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Check opportunities and risks within the IL real estate industry.

What is Electra Real Estate’s net debt?

You can click on the graph below for historical numbers, but it shows that in June 2022, Electra Real Estate had debt of $238.0 million, an increase of $190.4 million, on a year. However, since he has a cash reserve of $28.9 million, his net debt is less, at around $209.1 million.

TASE: ELCRE Debt to Equity November 14, 2022

A look at the liabilities of Electra Real Estate

According to the last published balance sheet, Electra Real Estate had liabilities of $89.8 million due within 12 months and liabilities of $260.2 million due beyond 12 months. In compensation for these obligations, it had cash of US$28.9 million as well as receivables valued at US$47.1 million and maturing within 12 months. It therefore has liabilities totaling $273.9 million more than its cash and short-term receivables, combined.

Electra Real Estate has a market capitalization of US$765.8 million, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.

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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Electra Real Estate’s net debt represents only 0.71 times its EBITDA. And its EBIT covers its interest charges 173 times. So we’re pretty relaxed about his super-conservative use of debt. Even better, Electra Real Estate increased its EBIT by 306% last year, which is an impressive improvement. 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. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Electra Real Estate has created free cash flow of 14% 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 truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. 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. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we found 3 warning signs for Electra Real Estate (2 are potentially serious!) which you should be aware of before investing here.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

Valuation is complex, but we help make it simple.

Find out if Electra Real Estate is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

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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.