These 4 measures indicate that TIM (WSE:TIM) uses debt safely
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. 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. Like many other companies TIM S.A. (WSE:TIM) uses debt. But does this debt worry shareholders?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for TIM
What is TIM’s net debt?
The image below, which you can click on for more details, shows that in September 2021, TIM had a debt of 11.1 million zł, compared to 85,000 zł in a year. However, since it has a cash reserve of 579.0 kzł, its net debt is lower, at around 10.5 million zł.
How healthy is TIM’s balance sheet?
The latest balance sheet data shows that TIM had liabilities of zł 271.6 million due within one year, and liabilities of zł 84.6 million falling due thereafter. As compensation for these obligations, it had cash of 579.0 kzł as well as receivables valued at 240.2 million zł payable within 12 months. Thus, its liabilities total zł 115.4 million more than the combination of its cash and short-term receivables.
Of course, TIM has a market capitalization of 890.2 million zł, so these liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. Either way, TIM has virtually no net debt, so it’s fair to say she’s not heavily in debt!
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.
With debt at a measly 0.086x EBITDA and an EBIT covering interest of 16.4x, it’s clear that TIM is not a desperate borrower. Indeed, relative to its earnings, its leverage seems light as a feather. What is even more impressive is that TIM increased its EBIT by 157% year-over-year. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since TIM will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
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, TIM has recorded free cash flow of 52% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
The good news is that TIM’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, TIM seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for TIM (1 is a little unpleasant!) which you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.