We think BT Group (LON:BT.A) is taking risks with its debt
Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, BT Group plc (LON:BT.A) is in debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for BT Group
What is BT Group’s debt?
As you can see below, BT Group had a debt of £21.9 billion in March 2022, roughly the same as the previous year. You can click on the graph for more details. However, he also had £3.39 billion in cash, so his net debt is £18.6 billion.
How healthy is BT Group’s balance sheet?
According to the latest published balance sheet, BT Group had liabilities of £9.05bn due within 12 months and liabilities of £25.4bn due beyond 12 months. In return, he had £3.39 billion in cash and £3.82 billion in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of £27.3 billion.
The deficiency here weighs heavily on Britain’s £14.0 billion society, like a child struggling under the weight of a huge backpack full of books, his sports gear and a trumpet. So we definitely think shareholders need to watch this one closely. Ultimately, BT Group 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.
BT Group has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 4.1 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Fortunately, BT Group has grown its EBIT by 2.7% over the past year, slowly reducing its debt relative to its earnings. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine BT Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, BT Group has recorded a free cash flow of 48% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
Reflecting on BT Group’s attempt to rein in its total liabilities, we’re certainly not enthusiastic. That said, its ability to convert EBIT to free cash flow is not that much of a concern. Overall, it seems to us that BT Group’s balance sheet is really a risk for the business. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 3 warning signs for BT Group you need to be aware of, and 1 of them can’t be ignored.
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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