Is Telenor (OB:TEL) Using Too Much Debt?
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 note that Telenor ASA (OB:TEL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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 Telenor
What Is Telenor's Net Debt?
As you can see below, at the end of June 2019, Telenor had kr87.8b of debt, up from kr71.9b a year ago. Click the image for more detail. However, it also had kr42.7b in cash, and so its net debt is kr45.0b.
How Healthy Is Telenor's Balance Sheet?
According to the last reported balance sheet, Telenor had liabilities of kr81.0b due within 12 months, and liabilities of kr108.7b due beyond 12 months. Offsetting these obligations, it had cash of kr42.7b as well as receivables valued at kr20.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr126.5b.
This deficit isn't so bad because Telenor is worth a massive kr261.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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).
Telenor has a low net debt to EBITDA ratio of only 1.0. And its EBIT covers its interest expense a whopping 12.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Telenor grew its EBIT by 6.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Telenor'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Telenor recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Telenor's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Telenor can handle its debt fairly comfortably. 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. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Telenor insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
