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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies. Telesto S.A. (WSE:TLO) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Telesto’s Net Debt?
As you can see below, at the end of March 2019, Telesto had zł564.5k of debt, up from zł513.8k a year ago. Click the image for more detail. However, it also had zł166.3k in cash, and so its net debt is zł398.2k.
How Healthy Is Telesto’s Balance Sheet?
We can see from the most recent balance sheet that Telesto had liabilities of zł1.96m falling due within a year, and liabilities of zł495.1k due beyond that. On the other hand, it had cash of zł166.3k and zł1.75m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł537.5k.
Given Telesto has a market capitalization of zł11.5m, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Either way, since Telesto does have more debt than cash, it’s worth keeping an eye on its balance sheet.
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.
Telesto has a low net debt to EBITDA ratio of only 0.46. And its EBIT covers its interest expense a whopping 18.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although Telesto made a loss at the EBIT level, last year, it was also good to see that it generated zł289k in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can’t view debt in total isolation; since Telesto will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Telesto actually produced more free cash flow than EBIT over the last year. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
Happily, Telesto’s impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Telesto seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you’re interested in Telesto, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.