Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 T-Mobile US, Inc. (NASDAQ:TMUS) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is T-Mobile US’s Net Debt?

As you can see below, at the end of December 2021, T-Mobile US had US$74.2b of debt, up from US$71.1b a year ago. Click the image for more detail. However, it also had US$6.63b in cash, and so its net debt is US$67.6b.

A Look At T-Mobile US’ Liabilities

We can see from the most recent balance sheet that T-Mobile US had liabilities of US$23.5b falling due within a year, and liabilities of US$114.0b due beyond that. Offsetting these obligations, it had cash of US$6.63b as well as receivables valued at US$9.16b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$121.7b.

This deficit is considerable relative to its very significant market capitalization of US$166.1b, so it does suggest shareholders should keep an eye on T-Mobile US’ use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

T-Mobile US has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 3.0 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. We saw T-Mobile US grow its EBIT by 6.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to 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 T-Mobile US can strengthen its balance sheet over time.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, T-Mobile US burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We’d go so far as to say T-Mobile US’s conversion of EBIT to free cash flow was disappointing. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Overall, we think it’s fair to say that T-Mobile US has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There’s no doubt that we learn most about debt from the balance sheet.