These 4 Measures Indicate That Proximus (EBR:PROX) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Proximus PLC (EBR:PROX) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Proximus

How Much Debt Does Proximus Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Proximus had €3.55b of debt, an increase on €3.22b, over one year. However, because it has a cash reserve of €255.0m, its net debt is less, at about €3.30b.

A Look At Proximus' Liabilities

Zooming in on the latest balance sheet data, we can see that Proximus had liabilities of €3.28b due within 12 months and liabilities of €4.08b due beyond that. On the other hand, it had cash of €255.0m and €1.12b worth of receivables due within a year. So it has liabilities totalling €5.99b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €2.59b 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. At the end of the day, Proximus would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 2.4, Proximus uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.3 times interest expense) certainly does not do anything to dispel this impression. Notably Proximus's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Proximus 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Proximus recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Proximus's level of total liabilities was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Proximus's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. To that end, you should learn about the 3 warning signs we've spotted with Proximus (including 1 which shouldn't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.