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Is TE Connectivity (NYSE:TEL) A Risky Investment?

Editorial Staff by Editorial Staff
July 12, 2021
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Is TE Connectivity (NYSE:TEL) A Risky Investment?

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 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. We can see that TE Connectivity Ltd. (NYSE:TEL) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.

What Is TE Connectivity’s Debt?

As you can see below, TE Connectivity had US$4.12b of debt at March 2021, down from US$4.36b a year prior. On the flip side, it has US$1.76b in cash leading to net debt of about US$2.36b.

debt-equity-history-analysis
NYSE:TEL Debt to Equity History July 12th 2021

How Healthy Is TE Connectivity’s Balance Sheet?

We can see from the most recent balance sheet that TE Connectivity had liabilities of US$5.04b falling due within a year, and liabilities of US$6.15b due beyond that. Offsetting this, it had US$1.76b in cash and US$2.92b in receivables that were due within 12 months. So it has liabilities totalling US$6.51b more than its cash and near-term receivables, combined.

Since publicly traded TE Connectivity shares are worth a very impressive total of US$45.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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).

TE Connectivity’s net debt is only 0.87 times its EBITDA. And its EBIT easily covers its interest expense, being 52.1 times the size. So we’re pretty relaxed about its super-conservative use of debt. But the other side of the story is that TE Connectivity saw its EBIT decline by 7.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine TE Connectivity’s ability to maintain a healthy balance sheet going forward.

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. During the last three years, TE Connectivity generated free cash flow amounting to a very robust 81% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.

Our View

TE Connectivity’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Taking all this data into account, it seems to us that TE Connectivity takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 

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