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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Instone SA Real Estate Group (ETR: INS) uses debt in its activities. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Instone Real Estate Group
How much debt is Instone Real Estate Group?
As you can see below, Instone Real Estate Group had € 407.9 million in debt in March 2021, up from € 619.3 million the year before. However, he also had € 169.4 million in cash, so his net debt is € 238.4 million.
A look at the liabilities of Instone Real Estate Group
Zooming in on the latest balance sheet data, we can see that Instone Real Estate Group had a liability of 432.9 million euros due within 12 months and a liability of 370.3 million euros due in- of the. In compensation for these obligations, he had cash of € 169.4 million as well as receivables valued at € 341.9 million within 12 months. Its liabilities thus exceed the sum of its cash and its (short-term) receivables by € 291.9 million.
While that might sound like a lot, it’s not that bad since Instone Real Estate Group has a market capitalization of 1.26 billion euros, and so it could likely strengthen its balance sheet by raising capital if it had to. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Instone Real Estate Group has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 3.6 times. This suggests that while debt levels are significant, we would stop calling them problematic. Even more worrying, Instone Real Estate Group has seen its EBIT fall by 10.0% over the past twelve months. If it continues like this, paying off debt will be like running on a treadmill – a lot of effort for little progress. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Instone Real Estate Group can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts‘ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly verify whether this EBIT generates a corresponding free cash flow. In the past three years, Instone Real Estate Group free cash flow has been 42% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
Both Instone Real Estate Group’s EBIT growth rate and interest coverage were disheartening. At least his total liability level gives us reason to be optimistic. Taking the above factors together, we believe that Instone Real Estate Group debt presents certain risks to the business. So while this leverage increases returns on equity, we wouldn’t really want to see it increase from here. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Instone Real Estate Group you should know.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth stocks today.
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