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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Eutelsat Communications S.A. (EPA:ETL) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
View our latest analysis for Eutelsat Communications
How Much Debt Does Eutelsat Communications Carry?
The image below, which you can click on for greater detail, shows that at December 2018 Eutelsat Communications had debt of €4.11b, up from €3.30b in one year. However, it also had €1.56b in cash, and so its net debt is €2.55b.
A Look At Eutelsat Communications's Liabilities
The latest balance sheet data shows that Eutelsat Communications had liabilities of €1.28b due within a year, and liabilities of €4.43b falling due after that. On the other hand, it had cash of €1.56b and €327.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.82b.
This is a mountain of leverage relative to its market capitalization of €3.92b. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).