Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Shenandoah Telecommunications Company (NASDAQ:SHEN) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Shenandoah Telecommunications's Debt?
The chart below, which you can click on for greater detail, shows that Shenandoah Telecommunications had US$692.5m in debt in December 2020; about the same as the year before. However, it does have US$195.4m in cash offsetting this, leading to net debt of about US$497.1m.
How Healthy Is Shenandoah Telecommunications' Balance Sheet?
We can see from the most recent balance sheet that Shenandoah Telecommunications had liabilities of US$1.21b falling due within a year, and liabilities of US$241.3m due beyond that. Offsetting these obligations, it had cash of US$195.4m as well as receivables valued at US$70.4m due within 12 months. So it has liabilities totalling US$1.18b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Shenandoah Telecommunications has a market capitalization of US$2.43b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenandoah Telecommunications can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Shenandoah Telecommunications reported revenue of US$221m, which is a gain of 4.4%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months Shenandoah Telecommunications produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$1.1m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of US$166m and a profit of US$2.6m. So one might argue that there's still a chance it can get things on the right track. 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. We've identified 1 warning sign with Shenandoah Telecommunications , and understanding them should be part of your investment process.
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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