Vonovia (ETR:VNA) Using debt could be considered risky

Howard Marks summed it up when he said: “Instead of worrying about share price volatility, the possibility of permanent loss is the risk I worry about… and every practical investor I know worries about So it seems that smart people know that debt – which usually accompanies bankruptcies – is a very important factor when assessing a company’s risk. As with many other companies Vonovia SE (ETR:VNA) uses debt. But should shareholders be concerned about the use of debt?

When is debt dangerous?

Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either through free cash flow or by raising capital at an attractive price. If the company can’t meet its legal obligations to pay down debt, shareholders could end up with nothing. However, a more common (but still painful) scenario involves having to raise new equity capital at a low price, resulting in permanent shareholder dilution. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high returns. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our current analysis for Vonovia

How high is Vonovia’s net debt?

As you can see below, Vonovia had debts of €43.1 billion as of September 2024, which is roughly the same as the previous year. For more details you can click on the chart. However, the company also had €2.10 billion in cash, putting its net debt at €41.0 billion.

A look at Vonovia’s liabilities

Taking a closer look at the latest balance sheet data, we see that Vonovia had liabilities of €6.66b due within 12 months and liabilities of €55.8b due beyond that. Offsetting these obligations, the company had cash of €2.10 billion and receivables worth €351.4 million due within 12 months. So its liabilities total €60.0b more than its cash and short-term receivables combined.

This deficit casts a shadow over the 25.8 billion euro company, like a colossus towering over mere mortals. So we definitely think shareholders should keep a close eye on this. After all, Vonovia would likely need a major recapitalization if it had to pay its creditors today.

To measure 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). We take into account both the absolute amount of the debt and the interest paid on it.

With a net debt to EBITDA ratio of 19.8, it’s fair to say that Vonovia has a significant amount of debt. However, interest coverage is reasonably high at 2.6, which is a good sign. Worse still: Vonovia’s EBIT fell by 21% last year. If profits stay that way over the long term, there’s a hell of a chance of paying off the debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is primarily future earnings that determine whether Vonovia can maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

After all, a company needs free cash flow to pay off debt; Book profits are simply not enough. So we definitely need to check whether that EBIT leads to corresponding free cash flow. To the delight of all shareholders, Vonovia has actually generated more free cash flow than EBIT over the last three years. There’s nothing like cash in when it comes to staying in your lender’s good graces.

Our view

At first glance, Vonovia’s EBIT growth rate made us uncertain about the stock, and its level of total liabilities was no more tempting than that one empty restaurant on the busiest night of the year. On the bright side, the conversion of EBIT to free cash flow is a good sign and makes us more optimistic. We are very clear that we consider Vonovia to be rather risky due to its balance sheet health. That’s why we’re almost as wary of this population as a hungry kitten when it falls into its owner’s fish pond: once bitten, twice shy, as the saying goes. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – quite the opposite. We’ve identified two warning signs with Vonovia (at least 1, which is a bit inconvenient), and understanding these points should be part of your investment process.

Ultimately, it’s often better to focus on companies that are free of net debt. You can access our special list of such companies (all with a track record of growing profits). It’s free.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.