Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt. (BUSE:BIF) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt's Net Debt?
The chart below, which you can click on for greater detail, shows that Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt had Ft20.8b in debt in June 2023; about the same as the year before. On the flip side, it has Ft545.9m in cash leading to net debt of about Ft20.3b.
A Look At Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt's Liabilities
Zooming in on the latest balance sheet data, we can see that Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt had liabilities of Ft3.44b due within 12 months and liabilities of Ft21.3b due beyond that. Offsetting these obligations, it had cash of Ft545.9m as well as receivables valued at Ft619.2m due within 12 months. So its liabilities total Ft23.5b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt is worth Ft99.7b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
We'd say that Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. Pleasingly, Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 217% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt reported free cash flow worth 14% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 Budapesti Ingatlan Hasznosítási és Fejlesztési Nyrt has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
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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