Does Aedas Homes (BME:AEDAS) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Aedas Homes, S.A. (BME:AEDAS) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. 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.

View our latest analysis for Aedas Homes

What Is Aedas Homes's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Aedas Homes had debt of €565.2m, up from €521.0m in one year. However, it also had €157.1m in cash, and so its net debt is €408.1m.

A Look At Aedas Homes' Liabilities

Zooming in on the latest balance sheet data, we can see that Aedas Homes had liabilities of €651.5m due within 12 months and liabilities of €318.5m due beyond that. Offsetting this, it had €157.1m in cash and €93.8m in receivables that were due within 12 months. So it has liabilities totalling €719.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €1.03b, so it does suggest shareholders should keep an eye on Aedas Homes' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.

Aedas Homes's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 12.0 times, makes us even more comfortable. Pleasingly, Aedas Homes is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 153% gain 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 Aedas Homes'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last two 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

We feel some trepidation about Aedas Homes's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its EBIT growth rate and interest cover were encouraging signs. We think that Aedas Homes's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. 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 shouldn't be ignored!) that you should be aware of before investing here.

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.

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.