Teleste (HEL:TLT1V) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Teleste Corporation (HEL:TLT1V) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Teleste

How Much Debt Does Teleste Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Teleste had debt of €27.3m, up from €24.3m in one year. On the flip side, it has €20.2m in cash leading to net debt of about €7.03m.

How Strong Is Teleste's Balance Sheet?

According to the last reported balance sheet, Teleste had liabilities of €42.7m due within 12 months, and liabilities of €27.2m due beyond 12 months. Offsetting this, it had €20.2m in cash and €29.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €20.4m.

Since publicly traded Teleste shares are worth a total of €104.6m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Teleste has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 11.5 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Teleste's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Teleste'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Teleste recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Teleste's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Teleste's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Teleste you should know about.

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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