Here's Why Real Fastigheter (NGM:REAL B) Has A Meaningful Debt Burden

By
Simply Wall St
Published
June 07, 2021
NGM:REAL B
Source: Shutterstock

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Real Fastigheter AB (publ) (NGM:REAL B) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Real Fastigheter

How Much Debt Does Real Fastigheter Carry?

The image below, which you can click on for greater detail, shows that Real Fastigheter had debt of kr342.8m at the end of March 2021, a reduction from kr403.7m over a year. And it doesn't have much cash, so its net debt is about the same.

debt-equity-history-analysis
NGM:REAL B Debt to Equity History June 8th 2021

How Healthy Is Real Fastigheter's Balance Sheet?

We can see from the most recent balance sheet that Real Fastigheter had liabilities of kr261.9m falling due within a year, and liabilities of kr133.6m due beyond that. On the other hand, it had cash of kr5.10m and kr14.2m worth of receivables due within a year. So its liabilities total kr376.2m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of kr274.9m, we think shareholders really should watch Real Fastigheter's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Real Fastigheter shareholders face the double whammy of a high net debt to EBITDA ratio (10.0), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Real Fastigheter actually grew its EBIT by a hefty 129%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Real Fastigheter's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Real Fastigheter actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Real Fastigheter's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Real Fastigheter to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should learn about the 3 warning signs we've spotted with Real Fastigheter (including 1 which doesn't sit too well with us) .

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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