Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Millicom International Cellular S.A. (NASDAQ:TIGO) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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.

How Much Debt Does Millicom International Cellular Carry?

As you can see below, Millicom International Cellular had US$5.65b of debt at March 2021, down from US$6.83b a year prior. However, because it has a cash reserve of US$780.0m, its net debt is less, at about US$4.87b.

A Look At Millicom International Cellular’s Liabilities

The latest balance sheet data shows that Millicom International Cellular had liabilities of US$2.41b due within a year, and liabilities of US$7.14b falling due after that. Offsetting this, it had US$780.0m in cash and US$537.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.23b.

The deficiency here weighs heavily on the US$4.15b 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, Millicom International Cellular would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Millicom International Cellular’s debt to EBITDA ratio (3.8) suggests that it uses some debt, its interest cover is very weak, at 0.39, suggesting high leverage. In large part that’s due to the company’s significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Millicom International Cellular’s EBIT was down 52% over the last year. If earnings keep going like that over the long term, it has a snowball’s chance in hell of paying off that 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 Millicom International Cellular 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Millicom International Cellular recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Millicom International Cellular’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. Considering everything we’ve mentioned above, it’s fair to say that Millicom International Cellular is carrying heavy debt load. If you play with fire you risk getting burnt, so we’d probably give this stock a wide berth. When analysing debt levels, the balance sheet is the obvious place to start.