These 4 Measures Indicate That Tele2 (STO:TEL2 B) Is Using Debt Reasonably Well

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Tele2 AB (publ) (STO:TEL2 B) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tele2

How Much Debt Does Tele2 Carry?

As you can see below, at the end of December 2022, Tele2 had kr28.7b of debt, up from kr25.4b a year ago. Click the image for more detail. However, it also had kr1.27b in cash, and so its net debt is kr27.4b.

How Healthy Is Tele2's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tele2 had liabilities of kr10.3b due within 12 months and liabilities of kr33.7b due beyond that. On the other hand, it had cash of kr1.27b and kr6.02b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr36.7b.

While this might seem like a lot, it is not so bad since Tele2 has a market capitalization of kr68.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

With net debt to EBITDA of 2.7 Tele2 has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.0 times its interest expense, and its net debt to EBITDA, was quite high, at 2.7. Tele2 grew its EBIT by 5.7% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tele2 can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Tele2 actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Tele2's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that Tele2 can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 instance, we've identified 3 warning signs for Tele2 (2 don't sit too well with us) you should be aware of.

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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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.