Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” It’s 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. We can see that PCCW Limited (HKG: 8) uses debt in his business. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first consider both liquidity and debt levels.
See our latest review for PCCW
What is PCCW’s net debt?
The graph below, which you can click for more details, shows that PCCW had HK $ 58.5 billion in debt as of June 2021; about the same as the year before. However, he has HK $ 7.59 billion in cash to make up for this, which leads to net debt of around HK $ 51.0 billion.
Is PCCW’s track record healthy?
Zooming in on the latest balance sheet data, we can see that PCCW had a liability of HK $ 20.0 billion owed within 12 months and a liability of HK $ 65.9 billion owed beyond that. In return, he had HK $ 7.59 billion in cash and HK $ 7.00 billion in receivables due within 12 months. Its liabilities therefore total HK $ 71.3 billion more than the combination of its cash and short-term receivables.
The lack here weighs heavily on the HK $ 31.0 billion business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. We therefore believe that shareholders should watch it closely. Ultimately, PCCW would likely need a major recapitalization if its creditors demanded repayment.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
PCCW shareholders are faced with the double whammy of a high net debt / EBITDA ratio (7.5) and relatively low interest coverage, since EBIT is only 2.4 times the expenses of ‘interests. This means that we would consider him to be in heavy debt. Investors should also be troubled that PCCW has seen its EBIT drop by 15% over the past twelve months. If things continue like this, managing debt will be about as easy as putting an angry house cat in its travel box. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether PCCW can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, PCCW has recorded free cash flow equal to 54% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
At first glance, PCCW’s net debt to EBITDA left us hesitant about the stock, and its total liability level was no more attractive than the single empty restaurant on the busiest night of the year. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Considering all of the above factors, it appears that PCCW has too much debt. While some investors like this kind of risky game, it is certainly not our cup of tea. 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. For example, we discovered 2 warning signs for PCCW (1 shouldn’t be ignored!) Which you should be aware of before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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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 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 the mentioned stocks.
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