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. We can see that Telefonaktiebolaget LM Ericsson (publ) (STO:ERIC B) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Telefonaktiebolaget LM Ericsson’s Debt?
As you can see below, at the end of December 2019, Telefonaktiebolaget LM Ericsson had kr37.7b of debt, up from kr33.4b a year ago. Click the image for more detail. But on the other hand it also has kr51.8b in cash, leading to a kr14.1b net cash position.
A Look At Telefonaktiebolaget LM Ericsson’s Liabilities
According to the last reported balance sheet, Telefonaktiebolaget LM Ericsson had liabilities of kr116.8b due within 12 months, and liabilities of kr77.7b due beyond 12 months. On the other hand, it had cash of kr51.8b and kr71.2b worth of receivables due within a year. So it has liabilities totalling kr71.5b more than its cash and near-term receivables, combined.
Telefonaktiebolaget LM Ericsson has a very large market capitalization of kr279.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Telefonaktiebolaget LM Ericsson also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Better yet, Telefonaktiebolaget LM Ericsson grew its EBIT by 117% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Telefonaktiebolaget LM Ericsson’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Telefonaktiebolaget LM Ericsson may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, Telefonaktiebolaget LM Ericsson’s free cash flow amounted to 46% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
While Telefonaktiebolaget LM Ericsson does have more liabilities than liquid assets, it also has net cash of kr14.1b. And it impressed us with its EBIT growth of 117% over the last year. So we don’t think Telefonaktiebolaget LM Ericsson’s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we’ve spotted with Telefonaktiebolaget LM Ericsson .
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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.
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