Warren Buffett famously said, ‘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 United States Cellular Corporation (NYSE:USM) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is United States Cellular’s Net Debt?
The image below, which you can click on for greater detail, shows that at December 2021 United States Cellular had debt of US$2.73b, up from US$2.49b in one year. On the flip side, it has US$156.0m in cash leading to net debt of about US$2.57b.
How Strong Is United States Cellular’s Balance Sheet?
According to the last reported balance sheet, United States Cellular had liabilities of US$903.0m due within 12 months, and liabilities of US$4.86b due beyond 12 months. Offsetting this, it had US$156.0m in cash and US$1.17b in receivables that were due within 12 months. So its liabilities total US$4.44b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$2.63b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. At the end of the day, United States Cellular would probably need a major re-capitalization if its creditors were to demand repayment.
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).
While we wouldn’t worry about United States Cellular’s net debt to EBITDA ratio of 3.0, we think its super-low interest cover of 1.1 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Notably, United States Cellular’s EBIT was pretty flat over the last year, which isn’t ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if United States Cellular can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, United States Cellular burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both United States Cellular’s conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Taking into account all the aforementioned factors, it looks like United States Cellular has too much debt. That sort of riskiness is ok for some, but it certainly doesn’t float our boat.