Hrvatski Telekom d.d (ZGSE:HT) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Hrvatski Telekom d.d. (ZGSE:HT) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Hrvatski Telekom d.d

What Is Hrvatski Telekom d.d's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Hrvatski Telekom d.d had debt of Kn207.0m, up from none in one year. But it also has Kn3.18b in cash to offset that, meaning it has Kn2.97b net cash.

How Strong Is Hrvatski Telekom d.d's Balance Sheet?

According to the last reported balance sheet, Hrvatski Telekom d.d had liabilities of Kn2.01b due within 12 months, and liabilities of Kn837.0m due beyond 12 months. Offsetting these obligations, it had cash of Kn3.18b as well as receivables valued at Kn1.84b due within 12 months. So it actually has Kn2.17b more liquid assets than total liabilities.

This short term liquidity is a sign that Hrvatski Telekom d.d could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hrvatski Telekom d.d boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Hrvatski Telekom d.d if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hrvatski Telekom d.d'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. Hrvatski Telekom d.d may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Hrvatski Telekom d.d generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Hrvatski Telekom d.d has Kn2.97b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in Kn1.0b. So we don't have any problem with Hrvatski Telekom d.d's use of debt. 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. Be aware that Hrvatski Telekom d.d is showing 1 warning sign in our investment analysis , 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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