Neinor Homes (BME:HOME) Seems To Use Debt Quite Sensibly

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 Neinor Homes, S.A. (BME:HOME) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Neinor Homes

How Much Debt Does Neinor Homes Carry?

You can click the graphic below for the historical numbers, but it shows that Neinor Homes had €211.4m of debt in June 2022, down from €403.3m, one year before. However, it does have €308.9m in cash offsetting this, leading to net cash of €97.5m.

A Look At Neinor Homes' Liabilities

Zooming in on the latest balance sheet data, we can see that Neinor Homes had liabilities of €561.6m due within 12 months and liabilities of €348.4m due beyond that. On the other hand, it had cash of €308.9m and €55.3m worth of receivables due within a year. So its liabilities total €545.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €594.6m, so it does suggest shareholders should keep an eye on Neinor Homes' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Neinor Homes boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Neinor Homes saw its EBIT slide 3.1% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Neinor Homes 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. Neinor Homes may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Neinor Homes actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Neinor Homes's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €97.5m. And it impressed us with free cash flow of €272m, being 170% of its EBIT. So we are not troubled with Neinor Homes's debt use. 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. Case in point: We've spotted 2 warning signs for Neinor Homes you should be aware of, and 1 of them makes us a bit uncomfortable.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.