Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Mostly, Uniti Group Limited (ASX: UWL) is in debt. But should shareholders be worried about its use of debt?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both cash and debt levels.
Discover our latest analysis for Uniti Group
What is Uniti Group’s net debt?
The image below, which you can click for more details, shows that as of December 2020, Uniti Group was in debt of A $ 301.2 million, compared to A $ 2.10 million in one year. However, given that it has a cash reserve of AU $ 48.1 million, its net debt is less, at around AU $ 253.0 million.
A look at the liabilities of the Uniti Group
We can see from the most recent balance sheet that Uniti Group had liabilities of A $ 62.0 million due within one year and liabilities of A $ 367.9 million beyond. In return, he had A $ 48.1 million in cash and A $ 14.9 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by A $ 366.8 million.
Given that Uniti Group has a market capitalization of A $ 2.25 billion, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
In this case, Uniti Group has a fairly worrying net debt to EBITDA ratio of 6.0 but very high interest coverage of 19.6. This means that unless the business has access to very cheap debt, these interest charges will likely increase in the future. Notably, Uniti Group recorded a loss in EBIT level last year, but improved it to a positive EBIT of AU $ 33 million in the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Uniti Group’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Uniti Group recorded free cash flow totaling 92% of its EBIT, which is higher than what we normally expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that the Uniti Group’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But we have to admit that we find that its net debt to EBITDA has the opposite effect. Looking at all of the above factors together, it seems to us that the Uniti Group can manage its debt quite comfortably. On the plus side, this leverage can increase returns for shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Uniti Group (1 of which doesn’t suit us very well!) you should know that.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth stocks today.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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