Here’s why Lumen Technologies (NYSE:LUMN) has significant debt

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Lumen Technologies, Inc. (NYSE:LUMN) 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. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for Lumen Technologies

What is Lumen Technologies’ net debt?

You can click on the chart below for historical numbers, but it shows Lumen Technologies had US$28.2 billion in debt in March 2022, up from US$31.1 billion a year prior. And he doesn’t have a lot of cash, so his net debt is about the same.

NYSE: LUMN Debt to Equity July 19, 2022

How strong is Lumen Technologies’ balance sheet?

The latest balance sheet data shows that Lumen Technologies had liabilities of $5.66 billion due within the year, and liabilities of $40.1 billion due thereafter. In return, it had $366.0 million in cash and $1.59 billion in receivables due within 12 months. Thus, its liabilities total $43.8 billion more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the $11.1 billion company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Lumen Technologies would likely need a major recapitalization if it were to pay its creditors today.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Lumen Technologies’ debt is 3.6 times its EBITDA, and its EBIT covers its interest expense 2.8 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Fortunately, Lumen Technologies has grown its EBIT by 8.2% over the past year, slowly reducing its debt to earnings ratio. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Lumen Technologies’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Lumen Technologies has recorded free cash flow of 86% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.

Our point of view

Reflecting on Lumen Technologies’ attempt to stay above its total liabilities, we’re certainly not enthused. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that Lumen Technologies’ debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. 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. For example, Lumen Technologies has 3 warning signs (and 2 that are concerning) that we think you should know about.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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.

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