We Think Veracruz Properties SOCIMI (BME:YVCP) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Veracruz Properties SOCIMI, S.A. (BME:YVCP) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Veracruz Properties SOCIMI

What Is Veracruz Properties SOCIMI's Net Debt?

As you can see below, Veracruz Properties SOCIMI had €41.2m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has €3.60m in cash leading to net debt of about €37.6m.

A Look At Veracruz Properties SOCIMI's Liabilities

Zooming in on the latest balance sheet data, we can see that Veracruz Properties SOCIMI had liabilities of €6.37m due within 12 months and liabilities of €38.2m due beyond that. On the other hand, it had cash of €3.60m and €1.31m worth of receivables due within a year. So its liabilities total €39.7m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Veracruz Properties SOCIMI is worth €84.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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).

Veracruz Properties SOCIMI has a rather high debt to EBITDA ratio of 8.4 which suggests a meaningful debt load. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. The good news is that Veracruz Properties SOCIMI improved its EBIT by 3.4% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. 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 Veracruz Properties 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. Over the last three years, Veracruz Properties SOCIMI recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Veracruz Properties SOCIMI's net debt to EBITDA was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Veracruz Properties SOCIMI's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 instance, we've identified 2 warning signs for Veracruz Properties SOCIMI (1 makes us a bit uncomfortable) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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