The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság (BUSE:MTELEKOM) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság Carry?
As you can see below, at the end of March 2021, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság had Ft412.8b of debt, up from Ft287.1b a year ago. Click the image for more detail. However, it does have Ft31.8b in cash offsetting this, leading to net debt of about Ft381.1b.
How Healthy Is Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's Balance Sheet?
According to the last reported balance sheet, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság had liabilities of Ft266.5b due within 12 months, and liabilities of Ft454.7b due beyond 12 months. On the other hand, it had cash of Ft31.8b and Ft164.0b worth of receivables due within a year. So it has liabilities totalling Ft525.5b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of Ft423.6b, we think shareholders really should watch Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's net debt of 2.1 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.5 times its interest expenses harmonizes with that theme. We saw Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság grow its EBIT by 5.8% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.
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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