Example of leverage ratios in action
Leverage ratios help put a company's absolute debt level into context with its ability to manage that debt.
For example, logistics real estate giant Prologis (PLD -1.35%) ended 2022 with almost $24 billion of debt, which sounds like a lot. However, the company's debt is only about 21% of its market cap. It also has a low leverage ratio (for a REIT) of 3.7 times debt-to-adjusted EBITDA and an excellent fixed-charge coverage ratio of 13.9. As a result, the company has A-rated credit. Prologis' low leverage ratios give it lots of financial flexibility to make investments to expand the business and pay dividends to shareholders.
We can also use leverage ratios to compare two similar companies. For example, rival industrial REIT Industrial Logistics Properties Trust (ILPT +0.32%) has $4.2 billion in debt. However, that's 75% of its total capital. The REIT also has a debt-to-EBITDAre ratio of 13.1 times, and it's using almost all its cash flow to pay the interest on its debt. Because of that, the company's near-term focus is on evaluating opportunities to improve its balance sheet and reduce leverage.
Using leverage ratios, investors can determine that Prologis has much less risk than Industrial Logistics Properties Trust, even though it has a considerably higher absolute debt level.
