Is Instone Real Estate Group (ETR:INS) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Instone Real Estate Group AG (ETR:INS) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Instone Real Estate Group

What Is Instone Real Estate Group's Debt?

As you can see below, Instone Real Estate Group had €407.9m of debt at March 2021, down from €619.3m a year prior. However, it also had €169.4m in cash, and so its net debt is €238.4m.

A Look At Instone Real Estate Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Instone Real Estate Group had liabilities of €432.9m due within 12 months and liabilities of €370.3m due beyond that. Offsetting these obligations, it had cash of €169.4m as well as receivables valued at €341.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €291.9m.

While this might seem like a lot, it is not so bad since Instone Real Estate Group has a market capitalization of €1.26b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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

Instone Real Estate Group has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 3.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. More concerning, Instone Real Estate Group saw its EBIT drop by 10.0% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Instone Real Estate Group can strengthen its balance sheet over time. 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. In the last three years, Instone Real Estate Group's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Instone Real Estate Group's EBIT growth rate and its interest cover were discouraging. At least its level of total liabilities gives us reason to be optimistic. Taking the abovementioned factors together we do think Instone Real Estate Group's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Instone Real Estate Group you should know about.

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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