Here's Why Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság (BUSE:MTELEKOM) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság

What Is Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's Debt?

As you can see below, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság had Ft363.4b of debt at March 2022, down from Ft412.8b a year prior. However, it does have Ft22.1b in cash offsetting this, leading to net debt of about Ft341.3b.

How Strong Is Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság had liabilities of Ft266.0b due within 12 months and liabilities of Ft411.8b due beyond that. Offsetting this, it had Ft22.1b in cash and Ft173.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Ft482.2b.

Given this deficit is actually higher than the company's market capitalization of Ft389.9b, 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. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 1.7, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.6 times its interest expenses harmonizes with that theme. Also good is that Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at staying on top of its total liabilities as wet socks are at keeping your feet warm. Looking at all this data makes us feel a little cautious about Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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, we've discovered 3 warning signs for Magyar Telekom Távközlési Nyilvánosan Müködö Részvénytársaság (1 is potentially serious!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.