Telephone and Data Systems (NYSE:TDS) Has No Shortage Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Telephone and Data Systems, Inc. (NYSE:TDS) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the US Wireless Telecom industry.

What Is Telephone and Data Systems's Net Debt?

The chart below, which you can click on for greater detail, shows that Telephone and Data Systems had US$3.47b in debt in June 2022; about the same as the year before. On the flip side, it has US$466.0m in cash leading to net debt of about US$3.01b.

How Healthy Is Telephone and Data Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Telephone and Data Systems had liabilities of US$1.23b due within 12 months and liabilities of US$6.25b due beyond that. Offsetting these obligations, it had cash of US$466.0m as well as receivables valued at US$1.21b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.81b.

This deficit casts a shadow over the US$1.67b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Telephone and Data Systems would probably need a major re-capitalization if its creditors were to demand repayment.

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). 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).

While Telephone and Data Systems's debt to EBITDA ratio (2.6) suggests that it uses some debt, its interest cover is very weak, at 1.8, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Unfortunately, Telephone and Data Systems saw its EBIT slide 5.7% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Telephone and Data Systems'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Telephone and Data Systems recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Telephone and Data Systems's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. After considering the datapoints discussed, we think Telephone and Data Systems has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. Be aware that Telephone and Data Systems is showing 3 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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.