Here's Why Ovaro Kiinteistösijoitus Oyj (HEL:OVARO) Has A Meaningful Debt Burden

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 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. Importantly, Ovaro Kiinteistösijoitus Oyj (HEL:OVARO) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ovaro Kiinteistösijoitus Oyj

What Is Ovaro Kiinteistösijoitus Oyj's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Ovaro Kiinteistösijoitus Oyj had debt of €11.1m, up from €6.95m in one year. However, because it has a cash reserve of €8.67m, its net debt is less, at about €2.47m.

How Strong Is Ovaro Kiinteistösijoitus Oyj's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ovaro Kiinteistösijoitus Oyj had liabilities of €1.62m due within 12 months and liabilities of €15.2m due beyond that. Offsetting these obligations, it had cash of €8.67m as well as receivables valued at €420.0k due within 12 months. So its liabilities total €7.72m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Ovaro Kiinteistösijoitus Oyj has a market capitalization of €24.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Ovaro Kiinteistösijoitus Oyj's net debt to EBITDA ratio of about 2.5 suggests only moderate use of debt. And its commanding EBIT of 20.4 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Ovaro Kiinteistösijoitus Oyj's EBIT fell a jaw-dropping 53% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ovaro Kiinteistösijoitus Oyj 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Ovaro Kiinteistösijoitus Oyj saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Ovaro Kiinteistösijoitus Oyj's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Ovaro Kiinteistösijoitus Oyj has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Ovaro Kiinteistösijoitus Oyj , 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.

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.