David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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 A.L.D. Advanced Logistics Developments Ltd. (TLV:ALD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for A.L.D. Advanced Logistics Developments
How Much Debt Does A.L.D. Advanced Logistics Developments Carry?
As you can see below, A.L.D. Advanced Logistics Developments had ₪7.40m of debt at June 2020, down from ₪10.7m a year prior. However, it also had ₪7.17m in cash, and so its net debt is ₪231.0k.
A Look At A.L.D. Advanced Logistics Developments’s Liabilities
We can see from the most recent balance sheet that A.L.D. Advanced Logistics Developments had liabilities of ₪25.6m falling due within a year, and liabilities of ₪13.9m due beyond that. Offsetting these obligations, it had cash of ₪7.17m as well as receivables valued at ₪34.6m due within 12 months. So it can boast ₪2.27m more liquid assets than total liabilities.
This short term liquidity is a sign that A.L.D. Advanced Logistics Developments could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, A.L.D. Advanced Logistics Developments has a very light debt load indeed.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
A.L.D. Advanced Logistics Developments’s net debt to EBITDA ratio is very low, at 0.043, suggesting the debt is only trivial. But EBIT was only 6.5 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Even more impressive was the fact that A.L.D. Advanced Logistics Developments grew its EBIT by 525% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is A.L.D. Advanced Logistics Developments’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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, A.L.D. Advanced Logistics Developments created free cash flow amounting to 6.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
Happily, A.L.D. Advanced Logistics Developments’s impressive EBIT growth rate implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Taking all this data into account, it seems to us that A.L.D. Advanced Logistics Developments takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with A.L.D. Advanced Logistics Developments , and understanding them should be part of your investment process.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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