Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Rogers Communications Inc. (TSE:RCI.B) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company 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.
How Much Debt Does Rogers Communications Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Rogers Communications had CA$18.2b of debt, an increase on CA$16.2b, over one year. However, it does have CA$404.0m in cash offsetting this, leading to net debt of about CA$17.7b.
How Healthy Is Rogers Communications's Balance Sheet?
According to the last reported balance sheet, Rogers Communications had liabilities of CA$6.06b due within 12 months, and liabilities of CA$20.7b due beyond 12 months. Offsetting these obligations, it had cash of CA$404.0m as well as receivables valued at CA$3.31b due within 12 months. So it has liabilities totalling CA$23.0b more than its cash and near-term receivables, combined.
This is a mountain of leverage even relative to its gargantuan market capitalization of CA$33.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Rogers Communications's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 5.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We saw Rogers Communications grow its EBIT by 3.6% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Rogers Communications can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Rogers Communications recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While Rogers Communications's level of total liabilities makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think Rogers Communications's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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