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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that IMMOBEL SA (EBR:IMMO) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
Check out our latest analysis for IMMOBEL
How Much Debt Does IMMOBEL Carry?
As you can see below, at the end of December 2018, IMMOBEL had €516.3m of debt, up from €400.5m a year ago. Click the image for more detail. However, because it has a cash reserve of €171.4m, its net debt is less, at about €345.0m.
A Look At IMMOBEL's Liabilities
According to the last reported balance sheet, IMMOBEL had liabilities of €288.7m due within 12 months, and liabilities of €332.9m due beyond 12 months. On the other hand, it had cash of €171.4m and €52.8m worth of receivables due within a year. So its liabilities total €397.5m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of €597.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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.
IMMOBEL's net debt is 4.9 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 20.9 times its interest expense, implying the company isn't really paying full freight on that debt. Even if not sustainable, that is a good sign. Notably, IMMOBEL's EBIT launched higher than Elon Musk, gaining a whopping 197% on last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if IMMOBEL 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.