ACCENTRO Real Estate (ETR:A4Y) Seems To Be Using A Lot Of Debt

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.' 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, ACCENTRO Real Estate AG (ETR:A4Y) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for ACCENTRO Real Estate

How Much Debt Does ACCENTRO Real Estate Carry?

The image below, which you can click on for greater detail, shows that at June 2021 ACCENTRO Real Estate had debt of €653.8m, up from €452.4m in one year. However, because it has a cash reserve of €113.0m, its net debt is less, at about €540.9m.

How Strong Is ACCENTRO Real Estate's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ACCENTRO Real Estate had liabilities of €227.6m due within 12 months and liabilities of €498.0m due beyond that. On the other hand, it had cash of €113.0m and €91.8m worth of receivables due within a year. So it has liabilities totalling €520.8m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €220.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, ACCENTRO Real Estate would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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).

Weak interest cover of 0.71 times and a disturbingly high net debt to EBITDA ratio of 58.4 hit our confidence in ACCENTRO Real Estate like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, ACCENTRO Real Estate saw its EBIT tank 61% 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 it is future earnings, more than anything, that will determine ACCENTRO Real Estate'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.

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. Over the last three years, ACCENTRO Real Estate saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both ACCENTRO Real Estate's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that ACCENTRO Real Estate is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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 example ACCENTRO Real Estate has 2 warning signs (and 1 which is concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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