These 4 metrics indicate that Summit Real Estate Holdings (TLV:SMT) is using debt extensively

Some say that volatility, rather than leverage, is the best way for investors to think about risk, but Warren Buffett famously said that “volatility is far from synonymous with risk.” So it seems that smart money knows that debt — which usually plays a role in bankruptcies — is a very important factor when assessing a company’s risk. We can see that Summit Real Estate Holdings Ltd (TLV:SMT) uses debt in its business. But is that debt a problem for shareholders?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it’s at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, permanently diluting shareholders. The benefit of leverage, of course, is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high returns. When thinking about a company’s use of debt, let’s first consider cash and debt together.

Check out our latest analysis for Summit Real Estate Holdings

What is Summit Real Estate Holdings Debt?

The image below, which you can click for more details, shows that Summit Real Estate Holdings had ₪3.81 billion in debt in March 2022, up from ₪3.61 billion in one year. However, it also had ₪1.31 billion in cash, making its net debt ₪2.50 billion.

TASE:SMT Debt to Equity History June 7, 2022

How Healthy Is Summit Real Estate Holdings’ Balance Sheet?

From the most recent balance sheet, we can see that Summit Real Estate Holdings had liabilities of ₪402.4 million. On the other hand, it had cash of ₪1.31 billion and accounts receivable of ₪94.9 million, which within a year were due. So its liabilities are ₪3.24 billion more than the combination of cash and short-term receivables.

That deficit is sizeable relative to its £4.26 billion market cap, so it advises shareholders to keep an eye on Summit Real Estate Holdings’ use of debt. Should lenders demand that they shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company’s debt burden relative to its profitability by dividing its net debt by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how well its earnings before interest and taxes (EBIT) are covering its interest costs (interest coverage) . In this way, we take into account both the absolute amount of the debt and the interest paid on it.

Summit Real Estate Holdings has a fairly high debt-to-EBITDA ratio of 7.9, indicating it has a significant debt load. But the good news is that it offers a fairly reassuring interest rate coverage of 3.2, suggesting it can service its commitments responsibly. The good news is that Summit Real Estate Holdings improved its trailing 12-month EBIT by 3.6%, gradually reducing its debt as a percentage of earnings. Undoubtedly, we learn most about debt from the balance sheet. But you can’t look at debt entirely in isolation; because Summit Real Estate Holdings needs revenue to service those debts. So, if you’re interested in learning more about earnings, it might be worth checking out this long-term earnings trend chart.

After all, a business needs free cash flow to pay off debt; Accounting profits just don’t cut it. So we really need to see if that EBIT translates into free cash flow to match. Over the past three years, Summit Real Estate Holdings has had significant negative free cash flow overall. While this may reflect spending on growth, it makes borrowing far more risky.

Our view

At first glance, Summit Real Estate Holdings’ net debt-to-EBITDA ratio left us hesitant about the stock, and converting EBIT to free cash flow was no more enticing than that one empty restaurant on the busiest night of the year. But at least the EBIT growth rate isn’t that bad. We’re pretty confident that we rate Summit Real Estate Holdings as fairly risky given its strong balance sheet. So we’re almost as wary of this stock as a hungry kitten is about to fall into its owner’s fishpond: bite once, shy twice, as the saying goes. When analyzing debt, the balance sheet is the obvious place to start. However, the entire investment risk is not on the balance sheet – far from it. These risks can be difficult to detect. Every company has them and we discovered them 3 Warning Signs for Summit Real Estate Holdings (2 of which are a bit uncomfortable!) that you should know about.

If, after all that, you’re more interested in a fast-growing company with a rock-solid balance sheet, check out our list of net cash growth stocks right away.

This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

About Paige McCarthy

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