Aedas Homes (BME:AEDAS) Has No Shortage Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Aedas Homes, S.A. (BME:AEDAS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Aedas Homes

What Is Aedas Homes's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Aedas Homes had €383.4m of debt in September 2022, down from €562.7m, one year before. However, it also had €134.8m in cash, and so its net debt is €248.7m.

A Look At Aedas Homes' Liabilities

The latest balance sheet data shows that Aedas Homes had liabilities of €753.8m due within a year, and liabilities of €321.8m falling due after that. Offsetting these obligations, it had cash of €134.8m as well as receivables valued at €77.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €863.3m.

This deficit casts a shadow over the €546.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Aedas Homes would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Aedas Homes has net debt worth 2.0 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.3 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Aedas Homes's EBIT fell a jaw-dropping 31% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Aedas Homes can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Aedas Homes burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Aedas Homes's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Aedas Homes has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example, we've discovered 2 warning signs for Aedas Homes (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.

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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.