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 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. As with many other companies Metrovacesa S.A. (BME:MVC) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Metrovacesa
What Is Metrovacesa's Net Debt?
As you can see below, at the end of June 2021, Metrovacesa had €411.9m of debt, up from €354.9m a year ago. Click the image for more detail. However, it does have €259.2m in cash offsetting this, leading to net debt of about €152.7m.
How Strong Is Metrovacesa's Balance Sheet?
According to the last reported balance sheet, Metrovacesa had liabilities of €472.3m due within 12 months, and liabilities of €271.1m due beyond 12 months. Offsetting these obligations, it had cash of €259.2m as well as receivables valued at €21.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €462.9m.
This deficit isn't so bad because Metrovacesa is worth €1.04b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 Metrovacesa's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Given it has no significant operating revenue at the moment, shareholders will be hoping Metrovacesa can make progress and gain better traction for the business, before it runs low on cash.
Caveat Emptor
Importantly, Metrovacesa had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at €66m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled €24m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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 1 warning sign with Metrovacesa , and understanding them should be part of your investment process.
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.
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About BME:MVC
Adequate balance sheet with moderate growth potential.
