Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk’. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Altice USA, Inc. (NYSE:ATUS) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Altice USA Carry?
The image below, which you can click on for greater detail, shows that at September 2019 Altice USA had debt of US$24.2b, up from US$23.2k in one year. Net debt is about the same, since the it doesn’t have much cash.
How Healthy Is Altice USA’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Altice USA had liabilities of US$1.88b due within 12 months and liabilities of US$29.8b due beyond that. Offsetting this, it had US$175.1m in cash and US$443.2m in receivables that were due within 12 months. So its liabilities total US$31.1b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$18.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Altice USA would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Altice USA shareholders face the double whammy of a high net debt to EBITDA ratio (5.7), and fairly weak interest coverage, since EBIT is just 1.2 times the interest expense. This means we’d consider it to have a heavy debt load. Looking on the bright side, Altice USA boosted its EBIT by a silky 40% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Altice USA can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Altice USA recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While Altice USA’s level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. When we consider all the factors discussed, it seems to us that Altice USA is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn’t really want to see it increase from here. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 3 warning signs for Altice USA (1 doesn’t sit too well with us) you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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