Telecom Plus (LON:TEP) Has A Rock Solid Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Telecom Plus PLC (LON:TEP) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Telecom Plus

How Much Debt Does Telecom Plus Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Telecom Plus had UK£79.2m of debt, an increase on UK£69.7m, over one year. However, because it has a cash reserve of UK£41.4m, its net debt is less, at about UK£37.8m.

A Look At Telecom Plus' Liabilities

According to the last reported balance sheet, Telecom Plus had liabilities of UK£126.3m due within 12 months, and liabilities of UK£88.4m due beyond 12 months. Offsetting this, it had UK£41.4m in cash and UK£59.0m in receivables that were due within 12 months. So it has liabilities totalling UK£114.3m more than its cash and near-term receivables, combined.

Given Telecom Plus has a market capitalization of UK£1.11b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Telecom Plus has a low net debt to EBITDA ratio of only 0.57. And its EBIT covers its interest expense a whopping 21.4 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Telecom Plus grew its EBIT by 9.7% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Telecom Plus's ability to maintain a healthy balance sheet going forward. 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, Telecom Plus generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Telecom Plus's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It's also worth noting that Telecom Plus is in the Integrated Utilities industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that Telecom Plus is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. Take risks, for example - Telecom Plus has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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