Warren Buffett said that “volatility is anything but synonymous with risk”. So it seems that smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when evaluating how risky a company is. It is important to point out that AT&T Inc. (NYSE: T) carries debt. But the real question is whether this debt is making the company risky.
What risk does debt entail?
Debt is a tool to help companies grow, but if a company is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company is unable to meet its legal obligations to repay the debt, shareholders could leave with nothing. However, a more frequent (but still expensive) event is when a company has to issue shares at rock bottom prices, permanently diluting shareholders, just to support their balance sheet. Of course, the bright side of debt is that it often represents low-cost capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a company uses is to look at its liquidity and debt together.
See our latest analysis for AT&T
How much debt does AT&T carry?
You can click the graph below for the historical numbers, but it shows that as of September 2021 AT&T had $ 182.6 billion of debt, an increase of $ 160.2 billion, in one year. However, because it has a cash reserve of $ 21.3 billion, its net debt is less, at around $ 161.3 billion.
How healthy is AT & T’s balance sheet?
According to the latest reported balance sheet, AT&T had $ 81.6 billion of debt maturing within 12 months and liabilities of $ 284.2 billion maturing beyond 12 months. To compensate for this, it had $ 21.3 billion in cash and $ 20.4 billion in credits that would expire within 12 months. So its liabilities amount to $ 324.1 billion more than the combination of cash and short-term credit.
This deficit casts a shadow over the $ 191.4 billion company, like a behemoth towering over mere mortals. So we definitely think shareholders need to watch this closely. At the end of the day, AT&T would likely need a major recapitalization if its creditors demanded repayment.
We use two main ratios to inform us about debt levels versus earnings. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how many times your earnings before interest and taxes (EBIT) cover interest expense (or interest coverage , In short) . Therefore we consider the payable related to the earnings both with and without depreciation and amortization expenses.
AT & T’s debt is 3.0 times its EBITDA and its EBIT covers interest expense 4.5 times. This suggests that although debt levels are significant, we would stop before calling them problematic. We have seen AT&T increase its EBIT by 8.7% over the past twelve months. While this hardly gets our socks off, it’s good when it comes to debt. There is no doubt that we learn more about debt from the budget. But ultimately the company’s future profitability will decide whether AT&T can strengthen its balance sheet over time. So, if you want to see what the pros are thinking, you might find this free analyst profit forecast report interesting.
Finally, a company can only pay off debt with cold cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched to the actual free cash flow. For the past three years, AT&T has recorded free cash flow equal to 92% of its EBIT, which is stronger than we would normally expect. This allows you to pay off the debt if you wish.
Our point of view
Neither AT&T’s ability to manage its total liabilities nor its net debt on EBITDA gave us confidence in its ability to take on more debt. But the good news is that it appears to be able to easily convert EBIT into free cash flow. Taking the above factors together, we believe AT&T’s debt poses some risks to the company. So while that leverage increases returns on equity, we wouldn’t really want to see it increase from here. There is no doubt that we learn more about debt from the budget. However, not all investment risk lies within the balance sheet, far from it. To this end, you should be aware of the 4 warning signs we singled out with AT&T.
In the end, it’s sometimes easier to focus on companies that don’t even need debt. Readers can access a growing list of stocks with zero net debt 100% free, right now.
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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 an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell stock and does not take into account your goals or financial situation. We aim to provide you with long-term focused analytics driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.