Here's Why NEPI Rockcastle (JSE:NRP) Can Manage Its Debt Responsibly

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. As with many other companies NEPI Rockcastle N.V. (JSE:NRP) makes use of debt. But the more important question is: how much risk is that debt creating?

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

Check out our latest analysis for NEPI Rockcastle

What Is NEPI Rockcastle's Net Debt?

As you can see below, at the end of June 2023, NEPI Rockcastle had €2.61b of debt, up from €2.30b a year ago. Click the image for more detail. However, it also had €347.2m in cash, and so its net debt is €2.26b.

How Strong Is NEPI Rockcastle's Balance Sheet?

The latest balance sheet data shows that NEPI Rockcastle had liabilities of €278.8m due within a year, and liabilities of €3.03b falling due after that. On the other hand, it had cash of €347.2m and €80.2m worth of receivables due within a year. So it has liabilities totalling €2.88b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €3.48b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

NEPI Rockcastle's net debt to EBITDA ratio is 5.3 which suggests rather high debt levels, but its interest cover of 7.4 times suggests the debt is easily serviced. Our best guess is that the company does indeed have significant debt obligations. One way NEPI Rockcastle could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 17%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine NEPI Rockcastle's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, NEPI Rockcastle generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

On our analysis NEPI Rockcastle's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, net debt to EBITDA gives us cold feet. When we consider all the elements mentioned above, it seems to us that NEPI Rockcastle is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example NEPI Rockcastle has 4 warning signs (and 2 which shouldn't be ignored) 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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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.