Is S IMMO (VIE:SPI) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that S IMMO AG (VIE:SPI) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for S IMMO

What Is S IMMO's Debt?

As you can see below, at the end of December 2023, S IMMO had €1.95b of debt, up from €1.47b a year ago. Click the image for more detail. However, it also had €445.1m in cash, and so its net debt is €1.50b.

How Strong Is S IMMO's Balance Sheet?

We can see from the most recent balance sheet that S IMMO had liabilities of €461.5m falling due within a year, and liabilities of €2.02b due beyond that. Offsetting this, it had €445.1m in cash and €73.3m in receivables that were due within 12 months. So it has liabilities totalling €1.96b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €1.24b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, S IMMO would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

S IMMO has a rather high debt to EBITDA ratio of 10.4 which suggests a meaningful debt load. However, its interest coverage of 3.7 is reasonably strong, which is a good sign. The good news is that S IMMO grew its EBIT a smooth 40% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine S IMMO's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, S IMMO recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

While S IMMO's net debt to EBITDA has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think S IMMO's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for S IMMO you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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