Is Temenos (VTX:TEMN) using too much debt?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. 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. We can see that Temenos SA (VTX:TEMN) uses debt in its business. But should shareholders worry about its use of debt?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. 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.

See our latest analysis for Temenos

What is Temenos’ net debt?

As you can see below, Temenos had US$899.0 million in debt as of June 2022, up from US$1.05 billion the previous year. On the other hand, he has $105.7 million in cash, resulting in a net debt of around $793.3 million.

SWX:TEMN Debt to Equity History July 29, 2022

A look at the responsibilities of Temenos

We can see from the most recent balance sheet that Temenos had liabilities of US$672.5 million maturing in one year, and liabilities of US$1.00 billion due beyond. In return, he had $105.7 million in cash and $356.4 million in receivables due within 12 months. Thus, its liabilities total $1.21 billion more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not that bad since Temenos has a market capitalization of US$5.59 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Temenos’ net debt is 3.0 times its EBITDA, which is significant but still reasonable leverage. But its EBIT was around 14.8 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Unfortunately, Temenos’ EBIT actually fell 4.4% last year. If profits continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Temenos’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Fortunately for all shareholders, Temenos has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

Fortunately, Temenos’ impressive interest coverage means it has the upper hand on its debt. But truth be told, we think its net debt to EBITDA somewhat undermines that impression. Looking at all of the above factors together, it seems to us that Temenos can manage its debt quite comfortably. On the plus side, this leverage can increase shareholder returns, but the potential downside is greater risk of loss, so it’s worth keeping an eye on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Temenos displays 2 warning signs in our investment analysis you should know…

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.

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.

Comments are closed.