Zug Estates Holding (VTX:ZUGN) Takes On Some Risk With Its Use Of 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.' 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 Zug Estates Holding AG (VTX:ZUGN) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 Zug Estates Holding

What Is Zug Estates Holding's Net Debt?

As you can see below, Zug Estates Holding had CHF591.8m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CHF17.2m in cash leading to net debt of about CHF574.6m.

A Look At Zug Estates Holding's Liabilities

According to the last reported balance sheet, Zug Estates Holding had liabilities of CHF72.5m due within 12 months, and liabilities of CHF638.3m due beyond 12 months. Offsetting this, it had CHF17.2m in cash and CHF9.35m in receivables that were due within 12 months. So its liabilities total CHF684.2m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CHF994.5m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zug Estates Holding has a rather high debt to EBITDA ratio of 11.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 6.4 times, suggesting it can responsibly service its obligations. Sadly, Zug Estates Holding's EBIT actually dropped 8.1% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zug Estates Holding'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Zug Estates Holding actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Neither Zug Estates Holding's ability handle its debt, based on its EBITDA, nor its EBIT growth rate gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that Zug Estates Holding's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Zug Estates Holding (1 is potentially serious!) that you should be aware of before investing here.

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. 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.
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