Yahoo Finance Verizon Communications (NYSE:VZ) Use Of Debt Could Be Considered Risky
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 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. We note that Verizon Communications Inc. (NYSE:VZ) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Verizon Communications
What Is Verizon Communications's Debt?
The chart below, which you can click on for greater detail, shows that Verizon Communications had US$151.4b in debt in September 2023; about the same as the year before. On the flip side, it has US$4.31b in cash leading to net debt of about US$147.1b.
A Look At Verizon Communications' Liabilities
Zooming in on the latest balance sheet data, we can see that Verizon Communications had liabilities of US$55.7b due within 12 months and liabilities of US$230.1b due beyond that. Offsetting this, it had US$4.31b in cash and US$24.1b in receivables that were due within 12 months. So it has liabilities totalling US$257.3b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$157.1b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Verizon Communications 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). 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).
Verizon Communications's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 6.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Unfortunately, Verizon Communications saw its EBIT slide 4.0% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Verizon Communications 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Verizon Communications recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Our View
We'd go so far as to say Verizon Communications's level of total liabilities was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Verizon Communications's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Verizon Communications .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
