Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. 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. We notice that Swisscom AG (VTX: SCMN) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
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 costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Swisscom
What is Swisscom’s net debt?
The image below, which you can click for more details, shows that Swisscom had a debt of 6.68 billion francs at the end of September 2021, a reduction from 7.38 billion francs over one year. However, it has CHF 334.0 million in cash to compensate for this, leading to net debt of around CHF 6.35 billion.
Is Swisscom’s balance sheet healthy?
According to the last published balance sheet, Swisscom had commitments of 4.24 billion francs at less than 12 months and commitments of 9.71 billion francs for more than 12 months. On the other hand, it had a cash position of CHF 334.0 million and CHF 2.55 billion in receivables due within a year. It therefore has liabilities totaling 11.1 billion francs more than its combined cash and short-term receivables.
Swisscom has a very large market capitalization of CHF 26.8 billion, so it could very likely raise cash to improve its balance sheet, should the need arise. However, it is always worth taking a close look at one’s ability to repay debts.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Swisscom’s net debt / EBITDA ratio of around 1.7 suggests only a moderate use of debt. And its imposing EBIT of 25.4 times its interest costs, means the debt burden is as light as a peacock feather. Fortunately, Swisscom has increased its EBIT by 5.6% over the past year, which makes this debt even more manageable. When analyzing debt levels, the balance sheet is the obvious place to start. But it is above all future profits that will determine Swisscom’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
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. Over the past three years, Swisscom has achieved free cash flow of 86% of its EBIT in total, which is higher than what we normally expected. This positions it well to repay debt if it is desirable.
Our point of view
The good news is that Swisscom’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Taking all this data into account, it seems to us that Swisscom has a fairly reasonable approach to debt. This means that they are taking a bit more risk, in the hope of increasing shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 2 warning signs for Swisscom (1 is a bit nasty!) Which you should be aware of before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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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.