Shenandoah Telecommunications (NASDAQ:SHEN) Has A Somewhat Strained Balance Sheet

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.' 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. We can see that Shenandoah Telecommunications Company (NASDAQ:SHEN) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenandoah Telecommunications

How Much Debt Does Shenandoah Telecommunications Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Shenandoah Telecommunications had debt of US$149.9m, up from US$25.0m in one year. However, it does have US$37.3m in cash offsetting this, leading to net debt of about US$112.6m.

How Strong Is Shenandoah Telecommunications' Balance Sheet?

We can see from the most recent balance sheet that Shenandoah Telecommunications had liabilities of US$84.4m falling due within a year, and liabilities of US$319.9m due beyond that. Offsetting this, it had US$37.3m in cash and US$23.5m in receivables that were due within 12 months. So it has liabilities totalling US$343.6m 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$1.04b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shenandoah Telecommunications has a very low debt to EBITDA ratio of 1.3 so it is strange to see weak interest coverage, with last year's EBIT being only 0.33 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Shenandoah Telecommunications improved its EBIT from a last year's loss to a positive US$14m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenandoah Telecommunications'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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Shenandoah Telecommunications burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Shenandoah Telecommunications's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Shenandoah Telecommunications's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Shenandoah Telecommunications (1 is a bit unpleasant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.