Is Corporación Inmobiliaria Vesta. de (BMV:VESTA) Using Too Much Debt?

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.' 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. We can see that Corporación Inmobiliaria Vesta S.A.B. de C.V. (BMV:VESTA) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Corporación Inmobiliaria Vesta. de

What Is Corporación Inmobiliaria Vesta. de's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Corporación Inmobiliaria Vesta. de had US$844.1m of debt, an increase on US$714.9m, over one year. However, it also had US$136.6m in cash, and so its net debt is US$707.5m.

A Look At Corporación Inmobiliaria Vesta. de's Liabilities

The latest balance sheet data shows that Corporación Inmobiliaria Vesta. de had liabilities of US$13.2m due within a year, and liabilities of US$1.16b falling due after that. Offsetting this, it had US$136.6m in cash and US$31.0m in receivables that were due within 12 months. So its liabilities total US$1.00b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$1.06b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

With a net debt to EBITDA ratio of 5.9, it's fair to say Corporación Inmobiliaria Vesta. de does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.1 times, suggesting it can responsibly service its obligations. Given the debt load, it's hardly ideal that Corporación Inmobiliaria Vesta. de's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Corporación Inmobiliaria Vesta. de's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Corporación Inmobiliaria Vesta. de recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Corporación Inmobiliaria Vesta. de's struggle handle its debt, based on its EBITDA, had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its conversion of EBIT to free cash flow was refreshing. Taking the abovementioned factors together we do think Corporación Inmobiliaria Vesta. de's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Corporación Inmobiliaria Vesta. de (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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