Is IMMOBEL (EBR:IMMO) A Risky Investment?

Simply Wall St

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.

ENXTBR:IMMO Historical Debt, September 20th 2019

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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, IMMOBEL recorded negative free cash flow, in total. 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

We feel some trepidation about IMMOBEL's difficulty net debt to EBITDA, but we've got positives to focus on, too. To wit both its interest cover and EBIT growth rate were encouraging signs. We think that IMMOBEL's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Given IMMOBEL has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.