David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies LEG Immobilien AG (ETR:LEG) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for LEG Immobilien
What Is LEG Immobilien's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 LEG Immobilien had €5.65b of debt, an increase on €4.50b, over one year. However, it also had €848.8m in cash, and so its net debt is €4.80b.
How Healthy Is LEG Immobilien's Balance Sheet?
The latest balance sheet data shows that LEG Immobilien had liabilities of €786.2m due within a year, and liabilities of €7.12b falling due after that. Offsetting this, it had €848.8m in cash and €119.2m in receivables that were due within 12 months. So its liabilities total €6.94b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its very significant market capitalization of €8.72b, so it does suggest shareholders should keep an eye on LEG Immobilien's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
LEG Immobilien has a rather high debt to EBITDA ratio of 10.7 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. The good news is that LEG Immobilien improved its EBIT by 5.9% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if LEG Immobilien can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, LEG Immobilien recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
LEG Immobilien's net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its conversion of EBIT to free cash flow was refreshing. Looking at all the angles mentioned above, it does seem to us that LEG Immobilien is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with LEG Immobilien (including 2 which is make us uncomfortable) .
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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About XTRA:LEG
Moderate growth potential second-rate dividend payer.
