Is United Internet (ETR: UTDI) using too much debt?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Above all, United Internet AG (ETR: UTDI) carries the debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is United Internet’s net debt?
As you can see below, at the end of June 2021, United Internet had â¬ 1.97 billion in debt, up from â¬ 1.57 billion a year ago. Click on the image for more details. However, he has 176.5 million euros in cash to compensate for this, which leads to net debt of around 1.80 billion euros.
How strong is United Internet’s balance sheet?
The most recent balance sheet shows United Internet had â¬ 1.89 billion in liabilities due within one year and â¬ 2.99 billion in liabilities due beyond. In compensation for these commitments, it had cash of â¬ 176.5 million as well as receivables valued at â¬ 1.04 billion maturing in 12 months. It therefore has total liabilities of 3.66 billion euros more than its combined cash and short-term receivables.
This deficit is not that big as United Internet is worth 6.61 billion euros, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
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.
United Internet’s net debt to EBITDA ratio of around 1.6 suggests only moderate use of debt. And its imposing EBIT of 46.3 times its interest costs, means the debt burden is as light as a peacock feather. United Internet’s EBIT has been fairly stable over the past year, but that shouldn’t be a problem considering it doesn’t have a lot of debt. 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 United Internet’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, United Internet has generated strong free cash flow equivalent to 61% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
On the balance sheet, the highlight for United Internet was the fact that it appears to be able to cover its interest charges with its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, his total liability level makes us a little nervous about his debt. When you consider all of the above, it seems to us that United Internet is managing its debt quite well. That said, the load is heavy enough that we recommend that any shareholder watch it closely. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 3 warning signs with United Internet and understanding them should be part of your investment process.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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