Is Telekom Austria (VIE:TKA) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Telekom Austria AG (VIE:TKA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Telekom Austria

How Much Debt Does Telekom Austria Carry?

As you can see below, Telekom Austria had €2.54b of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had €550.3m in cash, and so its net debt is €1.99b.

How Strong Is Telekom Austria's Balance Sheet?

We can see from the most recent balance sheet that Telekom Austria had liabilities of €2.17b falling due within a year, and liabilities of €3.31b due beyond that. Offsetting these obligations, it had cash of €550.3m as well as receivables valued at €880.7m due within 12 months. So it has liabilities totalling €4.04b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €4.80b, so it does suggest shareholders should keep an eye on Telekom Austria's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Telekom Austria has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.3 times, which is more than adequate. Fortunately, Telekom Austria grew its EBIT by 7.9% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Telekom Austria'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Telekom Austria recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

When it comes to the balance sheet, the standout positive for Telekom Austria was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think Telekom Austria is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Telekom Austria has 2 warning signs we think you should be aware of.

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.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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