Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies HIAG Immobilien Holding AG (VTX:HIAG) makes use of debt. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is HIAG Immobilien Holding's Net Debt?
The chart below, which you can click on for greater detail, shows that HIAG Immobilien Holding had CHF811.0m in debt in December 2020; about the same as the year before. However, it also had CHF19.7m in cash, and so its net debt is CHF791.3m.
How Strong Is HIAG Immobilien Holding's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HIAG Immobilien Holding had liabilities of CHF179.6m due within 12 months and liabilities of CHF750.7m due beyond that. Offsetting these obligations, it had cash of CHF19.7m as well as receivables valued at CHF14.8m due within 12 months. So it has liabilities totalling CHF895.7m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's CHF872.6m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
HIAG Immobilien Holding has a rather high debt to EBITDA ratio of 21.2 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.8 times, suggesting it can responsibly service its obligations. We also note that HIAG Immobilien Holding improved its EBIT from a last year's loss to a positive CHF37m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine HIAG Immobilien Holding's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, HIAG Immobilien Holding recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
We'd go so far as to say HIAG Immobilien Holding's net debt to EBITDA was disappointing. But at least its EBIT growth rate is not so bad. Looking at the bigger picture, it seems clear to us that HIAG Immobilien Holding'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. Be aware that HIAG Immobilien Holding is showing 4 warning signs in our investment analysis , and 1 of those is significant...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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