Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Telephone and Data Systems, Inc. (NYSE: TDS) carries the debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest analysis for phone and data systems
What is telephone and data system debt?
The graph below, which you can click for more details, shows Telephone and Data Systems owed US $ 3.00 billion in debt as of September 2021; about the same as the year before. However, he also had $ 725.0 million in cash, so his net debt is $ 2.27 billion.
A look at the responsibilities of telephone and data systems
Zooming in on the latest balance sheet data, we can see that the phone and data systems had a liability of US $ 1.29 billion owed within 12 months and a liability of US $ 5.42 billion owed beyond that. . On the other hand, he had cash of US $ 725.0 million and receivables worth US $ 1.27 billion within a year. It therefore has liabilities totaling US $ 4.71 billion more than its cash and short-term receivables combined.
The lack here weighs heavily on the $ 2.37 billion company itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . We would therefore monitor its record closely, without a doubt. After all, Telephone and Data Systems would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Telephone and Data Systems has a very reasonable net debt to EBITDA ratio of 1.9, its interest coverage appears weak at 1.2. The main reason is that it has such high depreciation and amortization. These charges can be non-monetary, so they could be excluded when it comes to paying off debt. But the accounting fees are there for a reason: some assets lose value. Either way, it’s safe to say that the business has significant debt. We have seen Telephone and Data Systems increase its EBIT by 4.9% over the past twelve months. It’s far from incredible, but it’s a good thing when it comes to paying down debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether Telephone and Data Systems can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, telephone and data systems have experienced significant negative free cash flow overall. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, Telephone and Data Systems’ EBIT conversion to free cash flow and its track record of controlling its total liabilities makes us rather uncomfortable with its debt levels. But at least its EBIT growth rate isn’t that bad. Considering all of the above factors, it looks like Telephone and Data Systems has too much debt. This kind of risk is acceptable to some, but it certainly does not float our boat. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for telephone and data systems you should know.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.