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I like to keep an eye on the developments of the real estate industry. Sometimes, I come across interesting investment options, like Vornado Realty Trust (NYSE:VNO), which will be declaring its earnings this Monday 24th of February. This real estate investment trust has an interesting set of company assets, including office and retail properties in New York and Washington, D.C., interests in neighborhood and regional shopping malls, Merchandise Mart properties, as well as unconventional investments in J.C. Penney Company, Inc. (NYSE:JCP).

However, over the past couple of years, the firm has divested many of these noncore assets, selling them for $3.5 billion, in order to focus business around the attractive leasing markets in Washington D.C. and New York, where $2.2 billion were invested for new asset acquisitions. This recent asset shift has made me focus this article on debt ratios and liabilities, as well as examine what analysts and other top investors think about this company. This analysis is crucial to understanding the risks of investing in this company, and will allow us to appreciate how leveraged a company is, and what kind of returns to expect for a long-term investment.

The idea behind Vornado's divesting strategy is to eventually focus on resources on the underlying property portfolio in profitable areas. By investing in these gateway markets, the company will benefit from an imbalance between restricted supply and excessive demand. Considering that 86% of the firm's income relies on the New York and Washington D.C locations, redirecting focus towards the core assets could boost this figure even further. So, by taking a closer look into the firm's debt scheme, we will be able to elucidate if the company is likely to maintain its capital, and use it for future growth.

Total Debt to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. When the outcome is higher than 1, it means that a company´s total debt surpasses the value of its total assets and when it is smaller than 1 the company's assets are worth more than its total debt. The total debt to total assets ratio can come in extremely handy when investors want to determine a company's level of risk.

Vornado's total debt to total assets ratio has decreased over the past three years, from 0.53 to 0.51. This indicates that since 2010, the company has added more total asset value than total debt, reflecting management's commitment to reduce debt. Given that the firm's ratio is smaller than 1, the financial risk faced by the company is relatively low: its assets´ value comfortably surpasses its total debt levels.

Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged" and are vulnerable to creditors if these start to demand repayment of debt.

Over the past three years, Vornado's total liabilities to total assets ratio has grown slightly, from 0.63 to 0.64. This is usually not a good sign, in my view because the 2013 TTM numbers are above the 0.50 mark indicate that the company has financed most of its assets through debt. Furthermore, this means that the risk of investing in the company has increased over time.

Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, resulting in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.

In Vornado's case, the debt-to-equity ratio increased from 2.04 in 2011 to 2.07 in 2013. I prefer companies that have a very low or minimal debt-to-equity ratio because that's a signal of a conservative balance sheet. The company´s ratio of 2.07 -which surpasses 1x- implies that the company faces high risks, and so do their investors. When analyzed, this figure entails that shareholders have invested more than suppliers, lenders, creditors and obligators.

Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which the company is using its equity to support operations and growth. Thus, companies with a high capitalization ratio are considered to be risky, as they will fail to repay their debt on time, increasing jeopardy of insolvency and making it difficult to get more loans in the future.

Since 2011, Vornado Realty Trust's capitalization ratio has decreased from 0.62 to 0.61, in 2013, showing that the firm´s equity, compared to its long-term debt, has grown, and serves the purpose of supporting operations and growth. This also implies a smaller financial risk for the company and its investors.

Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt, providing an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions.

As the ratio stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.

Institutional Investors
I generally assume that if a prominent investment guru put money into Vornado Realty Trust, the stock will pass strict fundamental standards. And so, I am relying on investment gurus George Soros and Steven Cohen, both of whom invested in the stock this past quarter at an average price of $87.13.

Analyst Outlook
Several analysts expect Vornado Realty Trust to perform well over the upcoming years. Analysts at Zacks Investment Research expect the company to retrieve FFO (funds from operations, which equals to operating earnings before non-recurring items) of $4.82 per share for FY 2013 and an FFO of $4.86 per share for FY 2014. Their projected FFO/share growth rate for the next 5 years barely reaches %4. On the other hand, the Bloomberg team estimates that revenue will reach $2.77B million for FY 2013 and $2.76B million for FY 2014. Finally, a median price target of $97.00 implies that there is still some upside potential left from this point.

Worth a Look

All in all, Vornado's balance sheet has shown positive progress. After divesting many of its non-traditional assets, the company has yet to pick up on its cash flow operation levels, although its capitalization ratio shows that it has become a somewhat better investment. Furthermore, as a real estate company with its main offices and retail space in New York and Washington D.C, it's strongly exposed to regional headwinds. In addition to this, the firm faces strong local competition from SL Green Realty Corp (NYSE:SLG), which also runs its core business in the big apple. However, I fell bullish about this company's future plans and am confident that it will be able to pay of its debt and boost cash flows through higher EBITDA margins.

Source: Will Vornado's Asset Divestment Solve Its Debt?