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.' 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. Importantly, Inmofam 99 SOCIMI, S.A. (BME:YINM) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Inmofam 99 SOCIMI
What Is Inmofam 99 SOCIMI's Debt?
The chart below, which you can click on for greater detail, shows that Inmofam 99 SOCIMI had €3.90m in debt in December 2020; about the same as the year before. However, because it has a cash reserve of €3.24m, its net debt is less, at about €662.7k.
How Healthy Is Inmofam 99 SOCIMI's Balance Sheet?
According to the last reported balance sheet, Inmofam 99 SOCIMI had liabilities of €3.84m due within 12 months, and liabilities of €540.3k due beyond 12 months. Offsetting these obligations, it had cash of €3.24m as well as receivables valued at €47.6k due within 12 months. So it has liabilities totalling €1.10m more than its cash and near-term receivables, combined.
Of course, Inmofam 99 SOCIMI has a market capitalization of €35.0m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Inmofam 99 SOCIMI's net debt is only 0.37 times its EBITDA. And its EBIT easily covers its interest expense, being 20.0 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Inmofam 99 SOCIMI's load is not too heavy, because its EBIT was down 27% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Inmofam 99 SOCIMI will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Inmofam 99 SOCIMI actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Our View
Happily, Inmofam 99 SOCIMI's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its EBIT growth rate has the opposite effect. When we consider the range of factors above, it looks like Inmofam 99 SOCIMI is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Inmofam 99 SOCIMI is showing 4 warning signs in our investment analysis , and 1 of those is a bit concerning...
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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About BME:YINM
Inmofam 99 SOCIMI
Acquires, owns, and leases commercial real estate properties in Spain.
Excellent balance sheet with proven track record.