NEPI Rockcastle (JSE:NRP) Takes On Some Risk With Its Use Of 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. As with many other companies NEPI Rockcastle N.V. (JSE:NRP) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for NEPI Rockcastle

How Much Debt Does NEPI Rockcastle Carry?

The image below, which you can click on for greater detail, shows that at December 2022 NEPI Rockcastle had debt of €2.60b, up from €2.30b in one year. However, it does have €261.1m in cash offsetting this, leading to net debt of about €2.34b.

A Look At NEPI Rockcastle's Liabilities

We can see from the most recent balance sheet that NEPI Rockcastle had liabilities of €199.1m falling due within a year, and liabilities of €3.05b due beyond that. Offsetting these obligations, it had cash of €261.1m as well as receivables valued at €76.0m due within 12 months. So its liabilities total €2.91b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €3.23b, so it does suggest shareholders should keep an eye on NEPI Rockcastle's use of debt. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

NEPI Rockcastle's net debt to EBITDA ratio is 6.2 which suggests rather high debt levels, but its interest cover of 7.0 times suggests the debt is easily serviced. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. We saw NEPI Rockcastle grow its EBIT by 9.8% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NEPI Rockcastle can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, NEPI Rockcastle produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

NEPI Rockcastle'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. Looking at all the angles mentioned above, it does seem to us that NEPI Rockcastle is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example NEPI Rockcastle has 3 warning signs (and 1 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.