Is Compañía Española de Viviendas en Alquiler (BME:CEV) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Compañía Española de Viviendas en Alquiler S.A. (BME:CEV) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Compañía Española de Viviendas en Alquiler

How Much Debt Does Compañía Española de Viviendas en Alquiler Carry?

As you can see below, at the end of June 2024, Compañía Española de Viviendas en Alquiler had €76.6m of debt, up from €66.4m a year ago. Click the image for more detail. However, because it has a cash reserve of €16.4m, its net debt is less, at about €60.2m.

A Look At Compañía Española de Viviendas en Alquiler's Liabilities

The latest balance sheet data shows that Compañía Española de Viviendas en Alquiler had liabilities of €23.8m due within a year, and liabilities of €158.2m falling due after that. On the other hand, it had cash of €16.4m and €1.37m worth of receivables due within a year. So it has liabilities totalling €164.2m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €171.4m, so it does suggest shareholders should keep an eye on Compañía Española de Viviendas en Alquiler's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

We'd say that Compañía Española de Viviendas en Alquiler's moderate net debt to EBITDA ratio ( being 2.5), indicates prudence when it comes to debt. And its strong interest cover of 11.2 times, makes us even more comfortable. Notably, Compañía Española de Viviendas en Alquiler made a loss at the EBIT level, last year, but improved that to positive EBIT of €24m in the last twelve months. 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 Compañía Española de Viviendas en Alquiler'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 is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Compañía Española de Viviendas en Alquiler recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We'd go so far as to say Compañía Española de Viviendas en Alquiler's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Compañía Española de Viviendas en Alquiler stock 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. Case in point: We've spotted 2 warning signs for Compañía Española de Viviendas en Alquiler you should be aware of.

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. 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.