Here’s Why Deutsche Telekom (ETR:DTE) Has Significant Leverage
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We notice that Deutsche Telekom AG (ETR:DTE) has debt on its balance sheet. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Discover our latest analysis for Deutsche Telekom
What is Deutsche Telekom’s debt?
The graph below, which you can click on for more details, shows that Deutsche Telekom had a debt of 108.9 billion euros in September 2021; about the same as the previous year. However, he has €6.34 billion in cash that offsets this, resulting in a net debt of around €102.6 billion.
How strong is Deutsche Telekom’s balance sheet?
According to the last published balance sheet, Deutsche Telekom had liabilities of 35.0 billion euros maturing within 12 months and liabilities of 159.5 billion euros maturing beyond 12 months. In return, it had 6.34 billion euros in cash and 16.4 billion euros in receivables due within 12 months. Thus, its liabilities total 171.8 billion euros more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the 76.3 billion euro company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Deutsche Telekom would likely need a large recapitalization if its creditors demanded repayment.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Deutsche Telekom has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest charges 3.1 times. This suggests that while debt levels are significant, we will refrain from labeling them problematic. On a lighter note, Deutsche Telekom increased its EBIT by 20% last year. If he can sustain that kind of improvement, his debt will start to melt like glaciers in a warming world. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Deutsche Telekom can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Deutsche Telekom’s free cash flow has been 50% of its EBIT, less than expected. That’s not great when it comes to paying off debt.
Our point of view
Reflecting on Deutsche Telekom’s attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that Deutsche Telekom’s use of debt creates risks for the company. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 2 warning signs we spotted with Deutsche Telekom.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.