Does TAG Immobilien (ETR:TEG) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, TAG Immobilien AG (ETR:TEG) does carry 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TAG Immobilien

What Is TAG Immobilien's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 TAG Immobilien had €3.09b of debt, an increase on €2.78b, over one year. However, because it has a cash reserve of €268.9m, its net debt is less, at about €2.82b.

How Strong Is TAG Immobilien's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TAG Immobilien had liabilities of €302.7m due within 12 months and liabilities of €3.62b due beyond that. Offsetting these obligations, it had cash of €268.9m as well as receivables valued at €19.1m due within 12 months. So its liabilities total €3.63b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €3.88b, so it does suggest shareholders should keep an eye on TAG Immobilien's use of debt. 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). 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 2.2 times and a disturbingly high net debt to EBITDA ratio of 10.4 hit our confidence in TAG Immobilien like a one-two punch to the gut. The debt burden here is substantial. On a lighter note, we note that TAG Immobilien grew its EBIT by 27% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. 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 TAG Immobilien 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, TAG Immobilien recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

TAG Immobilien's net debt to EBITDA was a real negative on this analysis, as was its interest cover. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about TAG Immobilien's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. We've identified 3 warning signs with TAG Immobilien (at least 2 which are significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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