Cellnex Telecom (BME:CLNX) Seems To Be Using A Lot Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Cellnex Telecom, S.A. (BME:CLNX) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Cellnex Telecom

What Is Cellnex Telecom's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Cellnex Telecom had €15.6b of debt, an increase on €12.0b, over one year. However, it does have €2.19b in cash offsetting this, leading to net debt of about €13.4b.

How Strong Is Cellnex Telecom's Balance Sheet?

We can see from the most recent balance sheet that Cellnex Telecom had liabilities of €2.62b falling due within a year, and liabilities of €23.0b due beyond that. Offsetting these obligations, it had cash of €2.19b as well as receivables valued at €1.21b due within 12 months. So its liabilities total €22.3b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of €27.7b, so it does suggest shareholders should keep an eye on Cellnex Telecom's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Cellnex Telecom shareholders face the double whammy of a high net debt to EBITDA ratio (9.3), and fairly weak interest coverage, since EBIT is just 0.29 times the interest expense. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that Cellnex Telecom actually let its EBIT decrease by 9.4% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cellnex Telecom can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Cellnex Telecom burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Cellnex Telecom's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its EBIT growth rate also fails to instill confidence. After considering the datapoints discussed, we think Cellnex Telecom has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. While Cellnex Telecom didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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. 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.