The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Anywhere Real Estate Inc. (NYSE:HOUS) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Anywhere Real Estate's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Anywhere Real Estate had US$2.81b of debt in June 2024, down from US$3.04b, one year before. On the flip side, it has US$128.0m in cash leading to net debt of about US$2.68b.
How Healthy Is Anywhere Real Estate's Balance Sheet?
According to the last reported balance sheet, Anywhere Real Estate had liabilities of US$1.50b due within 12 months, and liabilities of US$2.73b due beyond 12 months. Offsetting these obligations, it had cash of US$128.0m as well as receivables valued at US$364.0m due within 12 months. So its liabilities total US$3.74b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$544.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Anywhere Real Estate would probably need a major re-capitalization if its creditors were to demand repayment.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Weak interest cover of 0.24 times and a disturbingly high net debt to EBITDA ratio of 11.4 hit our confidence in Anywhere Real Estate like a one-two punch to the gut. The debt burden here is substantial. Even worse, Anywhere Real Estate saw its EBIT tank 35% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Anywhere Real Estate 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 always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Anywhere Real Estate recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
To be frank both Anywhere Real Estate's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its conversion of EBIT to free cash flow is not so bad. Considering all the factors previously mentioned, we think that Anywhere Real Estate really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Anywhere Real Estate you should be aware of.
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.
