Here’s why Telekom Austria (VIE:TKA) can manage its debt responsibly
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 synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Telekom Austria AG (LIFE:TKA) uses debt. But should shareholders worry about its use of debt?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Telekom Austria
What is Telekom Austria’s net debt?
The graph below, which you can click on for more details, shows that Telekom Austria had a debt of 2.55 billion euros in September 2021; about the same as the previous year. However, because it has a cash reserve of €675.3m, its net debt is lower, at around €1.87bn.
How strong is Telekom Austria’s balance sheet?
According to the latest published balance sheet, Telekom Austria had liabilities of €2.91 billion due within 12 months and liabilities of €2.51 billion due beyond 12 months. On the other hand, it has cash of €675.3 million and €920.5 million in receivables at less than one year. Thus, its liabilities total 3.82 billion euros more than the combination of its cash and short-term receivables.
That’s a mountain of leverage compared to its market capitalization of 5.11 billion euros. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Telekom Austria has a net debt of just 1.3 times EBITDA, indicating that it is certainly not an imprudent borrower. And it has interest coverage of 8.8 times, which is more than enough. And we also warmly note that Telekom Austria increased its EBIT by 20% last year, which makes it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Telekom Austria can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Telekom Austria has generated free cash flow amounting to 95% of its EBIT, a very solid result, above what we expected. This positions him well to pay off debt if desired.
Our point of view
Fortunately, Telekom Austria’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. But, on a darker note, we’re a bit concerned about his total passive level. Looking at all the above factors together, it seems to us that Telekom Austria can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Telekom Austria which you should be aware of before investing here.
If you are interested in investing in companies that can generate profits without the burden of debt, then 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.