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

By
Simply Wall St
Published
June 04, 2021
WBAG:SPI
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that S IMMO AG (VIE:SPI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for S IMMO

What Is S IMMO's Net Debt?

As you can see below, at the end of March 2021, S IMMO had €1.64b of debt, up from €1.51b a year ago. Click the image for more detail. On the flip side, it has €216.2m in cash leading to net debt of about €1.43b.

debt-equity-history-analysis
WBAG:SPI Debt to Equity History June 5th 2021

How Healthy Is S IMMO's Balance Sheet?

The latest balance sheet data shows that S IMMO had liabilities of €211.1m due within a year, and liabilities of €1.69b falling due after that. Offsetting this, it had €216.2m in cash and €4.88m in receivables that were due within 12 months. So its liabilities total €1.68b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of €1.58b, we think shareholders really should watch S IMMO's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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 its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

S IMMO has a rather high debt to EBITDA ratio of 19.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.3 times, suggesting it can responsibly service its obligations. Even worse, S IMMO saw its EBIT tank 28% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if S IMMO can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, S IMMO recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both S IMMO's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that S IMMO's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 4 warning signs with S IMMO (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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