Here's Why Preservia Hyresfastigheter (NGM:PHYR B) Can Afford Some Debt

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.' 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. Importantly, Preservia Hyresfastigheter AB (publ) (NGM:PHYR B) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Preservia Hyresfastigheter

What Is Preservia Hyresfastigheter's Debt?

As you can see below, at the end of April 2022, Preservia Hyresfastigheter had kr20.0m of debt, up from kr18.2m a year ago. Click the image for more detail. However, because it has a cash reserve of kr957.0k, its net debt is less, at about kr19.0m.

How Healthy Is Preservia Hyresfastigheter's Balance Sheet?

According to the last reported balance sheet, Preservia Hyresfastigheter had liabilities of kr416.0k due within 12 months, and liabilities of kr19.6m due beyond 12 months. Offsetting this, it had kr957.0k in cash and kr137.0k in receivables that were due within 12 months. So it has liabilities totalling kr18.9m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of kr30.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Preservia Hyresfastigheter's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given it has no significant operating revenue at the moment, shareholders will be hoping Preservia Hyresfastigheter can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

Over the last twelve months Preservia Hyresfastigheter produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at kr698k. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled kr6.4m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Preservia Hyresfastigheter (of which 3 make us uncomfortable!) 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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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.