Vonovia (ETR:VNA) Has A Somewhat Strained Balance Sheet

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.' 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.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Vonovia

What Is Vonovia's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Vonovia had debt of €25.6b, up from €23.5b in one year. However, because it has a cash reserve of €2.15b, its net debt is less, at about €23.4b.

How Healthy Is Vonovia's Balance Sheet?

The latest balance sheet data shows that Vonovia had liabilities of €3.58b due within a year, and liabilities of €35.5b falling due after that. Offsetting these obligations, it had cash of €2.15b as well as receivables valued at €361.0m due within 12 months. So its liabilities total €36.6b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's huge €29.0b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

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. However, the silver lining was that Vonovia achieved a positive EBIT of €1.7b in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Vonovia generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

We'd go so far as to say Vonovia's net debt to EBITDA was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Vonovia's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 5 warning signs with Vonovia (at least 2 which shouldn't be ignored) , 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.

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