Is Vonovia (ETR:VNA) A Risky Investment?

By
Simply Wall St
Published
August 09, 2021
XTRA:VNA
Source: Shutterstock

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.' 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. As with many other companies Vonovia SE (ETR:VNA) makes use of debt. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Vonovia

What Is Vonovia's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Vonovia had €25.6b of debt, an increase on €23.5b, over one year. However, it also had €2.15b in cash, and so its net debt is €23.4b.

debt-equity-history-analysis
XTRA:VNA Debt to Equity History August 10th 2021

How Strong Is Vonovia's Balance Sheet?

According to the last reported balance sheet, Vonovia had liabilities of €3.58b due within 12 months, and liabilities of €35.5b due beyond 12 months. Offsetting these obligations, it had cash of €2.15b as well as receivables valued at €361.0m due within 12 months. So it has liabilities totalling €36.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's massive market capitalization of €33.0b, we think shareholders really should watch Vonovia's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 13.6, it's fair to say Vonovia does have a significant amount of debt. However, its interest coverage of 4.4 is reasonably strong, which is a good sign. On a slightly more positive note, Vonovia grew its EBIT at 13% over the last year, further increasing its ability to manage debt. 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 Vonovia'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Vonovia generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Neither Vonovia's ability handle its debt, based on its EBITDA, nor its level of total liabilities 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. Looking at all the angles mentioned above, it does seem to us that Vonovia 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. When analysing debt levels, the balance sheet is the obvious place to start. 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 5 warning signs for Vonovia (of which 2 are potentially serious!) 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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