Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Shenandoah Telecommunications Company (NASDAQ:SHEN) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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, 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.

See our latest analysis for Shenandoah Telecommunications

What Is Shenandoah Telecommunications's Debt?

As you can see below, at the end of September 2023, Shenandoah Telecommunications had US$149.9m of debt, up from US$25.0m a year ago. Click the image for more detail. However, it does have US$37.3m in cash offsetting this, leading to net debt of about US$112.6m.

How Strong Is Shenandoah Telecommunications' Balance Sheet?

We can see from the most recent balance sheet that Shenandoah Telecommunications had liabilities of US$84.4m falling due within a year, and liabilities of US$319.9m due beyond that. Offsetting these obligations, it had cash of US$37.3m as well as receivables valued at US$23.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$343.6m.

This deficit isn't so bad because Shenandoah Telecommunications is worth US$1.24b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

Shenandoah Telecommunications has a very low debt to EBITDA ratio of 1.3 so it is strange to see weak interest coverage, with last year's EBIT being only 0.33 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Notably, Shenandoah Telecommunications made a loss at the EBIT level, last year, but improved that to positive EBIT of US$14m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenandoah Telecommunications's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Shenandoah Telecommunications burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Shenandoah Telecommunications's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Shenandoah Telecommunications's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Shenandoah Telecommunications you should be aware of, and 1 of them doesn't sit too well with us.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.