Does Technicolor (EPA:TCH) use too much debt?
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Technicolor AG (EPA:TCH) uses debt in its business. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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What is Technicolor’s debt?
You can click on the graph below for historical numbers, but it shows that in June 2022, Technicolor had 1.10 billion euros in debt, an increase from 1.04 billion euros, on a year. However, he has €168.0 million in cash to offset this, resulting in a net debt of around €928.0 million.
A look at Technicolor’s passives
According to the last published balance sheet, Technicolor had liabilities of 1.50 billion euros maturing within 12 months and liabilities of 1.50 billion euros maturing beyond 12 months. On the other hand, it had €168.0 million in cash and €511.0 million in receivables at less than one year. It therefore has liabilities totaling 2.33 billion euros more than its cash and short-term receivables, combined.
This deficit casts a shadow over the company of 636.8 million euros, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Technicolor would likely need a major recapitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Technicolor’s debt to EBITDA ratio (4.0) suggests it uses some debt, its interest coverage is very low at 0.68, suggesting high leverage. This is largely due to the company’s large amortization charges, which no doubt means that its EBITDA is a very generous measure of earnings, and that its debt may be heavier than it first appears. on board. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. However, the silver lining was that Technicolor achieved a positive EBIT of €92 million in the last twelve months, an improvement on the loss of the previous year. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Technicolor can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. In the most recent year, Technicolor recorded free cash flow of 63% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
At first glance, Technicolor’s interest coverage left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, it seems to us that Technicolor’s balance sheet is really a risk for the company. We are therefore almost as wary of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. Even though Technicolor lost money in net income, its positive EBIT suggests that the company itself has potential. You might want to check how income has changed over the past few years.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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