Is London & Associated Properties (LON:LAS) Using Too Much 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.' 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. We can see that London & Associated Properties Plc (LON:LAS) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for London & Associated Properties

How Much Debt Does London & Associated Properties Carry?

You can click the graphic below for the historical numbers, but it shows that London & Associated Properties had UK£26.1m of debt in December 2023, down from UK£39.2m, one year before. However, it also had UK£7.71m in cash, and so its net debt is UK£18.4m.

A Look At London & Associated Properties' Liabilities

Zooming in on the latest balance sheet data, we can see that London & Associated Properties had liabilities of UK£32.8m due within 12 months and liabilities of UK£16.5m due beyond that. Offsetting these obligations, it had cash of UK£7.71m as well as receivables valued at UK£7.41m due within 12 months. So its liabilities total UK£34.2m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the UK£8.96m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, London & Associated Properties would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.32 times and a disturbingly high net debt to EBITDA ratio of 6.3 hit our confidence in London & Associated Properties like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, London & Associated Properties's EBIT was down 97% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since London & Associated Properties 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, London & Associated Properties actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both London & Associated Properties's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think London & Associated Properties has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example - London & Associated Properties has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.