Is Swiss Prime Site (VTX:SPSN) Using Too Much Debt?

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. Importantly, Swiss Prime Site AG (VTX:SPSN) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Swiss Prime Site

What Is Swiss Prime Site's Debt?

The chart below, which you can click on for greater detail, shows that Swiss Prime Site had CHF5.15b in debt in December 2021; about the same as the year before. However, because it has a cash reserve of CHF114.7m, its net debt is less, at about CHF5.03b.

How Strong Is Swiss Prime Site's Balance Sheet?

According to the last reported balance sheet, Swiss Prime Site had liabilities of CHF380.7m due within 12 months, and liabilities of CHF6.41b due beyond 12 months. On the other hand, it had cash of CHF114.7m and CHF76.6m worth of receivables due within a year. So its liabilities total CHF6.60b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CHF6.37b 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.

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

While Swiss Prime Site's debt to EBITDA ratio of 12.5 suggests a heavy debt load, its interest coverage of 9.0 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Shareholders should be aware that Swiss Prime Site's EBIT was down 29% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Swiss Prime Site'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Swiss Prime Site produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Swiss Prime Site's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Swiss Prime Site stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Swiss Prime Site (2 shouldn't be ignored) you should be aware of.

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.