Is PSP Swiss Property (VTX:PSPN) 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 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. As with many other companies PSP Swiss Property AG (VTX:PSPN) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for PSP Swiss Property

What Is PSP Swiss Property's Debt?

As you can see below, PSP Swiss Property had CHF3.09b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is PSP Swiss Property's Balance Sheet?

We can see from the most recent balance sheet that PSP Swiss Property had liabilities of CHF555.4m falling due within a year, and liabilities of CHF3.73b due beyond that. Offsetting these obligations, it had cash of CHF21.1m as well as receivables valued at CHF16.6m due within 12 months. So its liabilities total CHF4.25b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CHF4.78b, so it does suggest shareholders should keep an eye on PSP Swiss Property's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely PSP Swiss Property has a sky high EBITDA ratio of 10.5, implying high debt, but a strong interest coverage of 24.3. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably PSP Swiss Property's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PSP Swiss Property'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 always check how much of that EBIT is translated into free cash flow. During the last three years, PSP Swiss Property generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

PSP Swiss Property's net debt to EBITDA was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about PSP Swiss Property's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should learn about the 4 warning signs we've spotted with PSP Swiss Property (including 2 which shouldn't be ignored) .

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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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.