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.” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Tele2 AB (released) (STO: TEL2 B) uses debt. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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 must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is Tele2’s net debt?
The graph below, which you can click for more details, shows that Tele2 had a debt of 28.3 billion kr in September 2021; about the same as the year before. However, he also had 2.47 billion crowns in cash, so his net debt is 25.8 billion crowns.
Is Tele2’s track record healthy?
We can see from the most recent balance sheet that Tele2 had liabilities of KKr 13.0 billion due within one year, and KKr 31.7 billion debts due beyond. On the other hand, he had a treasury of 2.47 billion crowns and 4.60 billion crowns of debts due within one year. Its liabilities therefore total 37.7 billion crowns more than the combination of its cash and short-term receivables.
Tele2 has a market capitalization of SEK 83.5 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Tele2 has a debt to EBITDA ratio of 2.7, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 11.7 is very high, suggesting that interest charges on debt are currently quite low. The bad news is that Tele2 has seen its EBIT drop by 11% over the past year. If incomes continue to drop at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Tele2’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Tele2 has actually generated more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
Tele2’s ability to convert EBIT into free cash flow and its interest coverage have bolstered our ability to manage debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Tele2 manages its debt quite well. That said, the load is heavy enough that we recommend that any shareholder watch it closely. When analyzing debt levels, the balance sheet is the obvious starting point. 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 4 warning signs for Tele2 (of which 1 is of concern!) that you should know about.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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 shares 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 material. Simply Wall St has no position in any of the stocks mentioned.
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