We Think Swisscom (VTX:SCMN) Can Stay On Top Of Its Debt

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. As with many other companies Swisscom AG (VTX:SCMN) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Swisscom

What Is Swisscom's Net Debt?

The image below, which you can click on for greater detail, shows that Swisscom had debt of CHF6.88b at the end of March 2021, a reduction from CHF8.41b over a year. However, because it has a cash reserve of CHF694.0m, its net debt is less, at about CHF6.19b.

How Healthy Is Swisscom's Balance Sheet?

We can see from the most recent balance sheet that Swisscom had liabilities of CHF4.28b falling due within a year, and liabilities of CHF10.4b due beyond that. On the other hand, it had cash of CHF694.0m and CHF2.65b worth of receivables due within a year. So it has liabilities totalling CHF11.3b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Swisscom has a huge market capitalization of CHF27.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Swisscom's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 19.9 times, makes us even more comfortable. Importantly Swisscom's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Swisscom 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Swisscom generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Swisscom's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. All these things considered, it appears that Swisscom can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Case in point: We've spotted 2 warning signs for Swisscom you should be aware of, and 1 of them doesn't sit too well with us.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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