Legendary fund manager Li Lu (who backed Charlie Munger) once said, “The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.” It seems that smart investors know that debt – which is usually involved in bankruptcies – is a very important factor when assessing how risky a company is. As with many other companies Orascom Development Holding AG (VTX:ODHN) uses debt. But the real question is whether this debt makes the company risky.

What risk does debt entail?

Debt aids a company until the company has difficulty paying it off, either with new capital or with free cash flow. A regular feature of capitalism is the process of “creative destruction,” in which bankrupt companies are mercilessly liquidated by their bankers. A more common (but still expensive) situation, however, is that a company must dilute shareholders at a cheap share price in order to get its debt under control. Debt can of course be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.

View our latest analysis for Orascom Development Holding

What is the net debt of Orascom Development Holding?

The image below, which you can click on for greater detail, shows that Orascom Development Holding had debt of CHF498.2 million at March 2024, up from CHF467.1 million in one year. On the other hand, it has CHF216.9 million in cash, leading to net debt of around CHF281.3 million.

debt-equity-history-analysis
SWX:ODHN Debt/Equity History July 4, 2024

A look at Orascom Development Holding’s obligations

According to its last reported balance sheet, Orascom Development Holding had liabilities of CHF657.3 million due within 12 months, and liabilities of CHF581.5 million due beyond 12 months. Against these obligations, it had cash of CHF216.9 million and receivables worth CHF176.3 million due within 12 months. So it has liabilities totalling CHF845.6 million more than its cash and short-term receivables, combined.

The deficit here weighs heavily on the CHF255.2 million company itself, as if a child were struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet. So we would keep a close eye on the balance sheet, no doubt. Ultimately, Orascom Development Holding would probably need a major recapitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times earnings before interest and tax (EBIT) covers interest expense (or interest cover for short). So we consider debt relative to earnings with and without depreciation and amortization expenses.

Orascom Development Holding has net debt of 2.1 times EBITDA, which isn’t much, but its interest cover seems a little on the low side, with EBIT at just 3.1 times interest expenses. While these numbers don’t set us off, it’s worth noting that the company’s cost of debt is having a real impact. If Orascom Development Holding can grow EBIT at last year’s 11% rate, it will find its debt load easier to manage. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, the future profitability of the business will determine whether Orascom Development Holding can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company needs free cash flow to pay down debt; accounting profits simply aren’t enough. So we need to look closely at whether that EBIT is leading to a corresponding free cash flow. Over the past three years, Orascom Development Holding has seen substantial negative free cash flow in aggregate. While investors would no doubt expect that situation to reverse over time, it clearly means that using debt is riskier.

Our point of view

At first glance, Orascom Development Holding’s conversion of EBIT to free cash flow made us doubtful about the stock, and the level of total liabilities was no more attractive than one empty restaurant on the busiest night of the year. But on the positive side, the EBIT growth is a good sign and makes us more optimistic. Overall, it seems to us that Orascom Development Holding’s balance sheet really does pose a significant risk to the company. For this reason, we are quite cautious about the stock and believe that shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is an obvious place to start. However, not all investment risks lie in the balance sheet – far from it. For example, we have 1 warning sign for Orascom Development Holding what you should be aware of.

If you’re interested in investing in companies that can make a profit without the burden of debt, check this out free list of growing companies with net cash on the balance sheet.

Valuation is complex, but we make it simple.

Find out if Orascom Development Holding may be over or undervalued by looking at our comprehensive analysis, which includes: fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article from Simply Wall St is general in nature. We comment solely on historical data and analyst forecasts, using an objective methodology. Our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your objectives or financial situation. We aim to provide you with a long-term analysis driven by fundamental data. Please 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 the shares mentioned.

Valuation is complex, but we make it simple.

Find out if Orascom Development Holding may be over or undervalued by looking at our comprehensive analysis, which includes: fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the free analysis

Do you have feedback on this article? Are you concerned about the content? Please contact us directly. You can also send an email to [email protected]