Is Koninklijke KPN (AMS:KPN) a risky investment?

Warren Buffett said: “Volatility is far from synonymous with risk. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Koninklijke KPN NV (AMS:KPN) is in debt. But does this debt worry shareholders?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Koninklijke KPN

What is Koninklijke KPN’s net debt?

As you can see below, Koninklijke KPN had 6.41 billion euros in debt, as of June 2022, which is about the same as the previous year. You can click on the graph for more details. On the other hand, it has €669.0 million in cash, resulting in a net debt of around €5.74 billion.

ENXTAM: KPN Debt to Equity History August 25, 2022

How strong is Koninklijke KPN’s balance sheet?

We can see from the most recent balance sheet that Koninklijke KPN had liabilities of €2.28 billion due in one year, and liabilities of €6.68 billion due beyond. In return, it had €669.0 million in cash and €794.0 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €7.49 billion.

While that might sound like a lot, it’s not too bad since Koninklijke KPN has a huge market capitalization of €13.1 billion, and so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it must be carefully examined whether he can manage his debt without dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Koninklijke KPN has a debt/EBITDA ratio of 2.7 and its EBIT covered its interest charges 5.1 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. If Koninklijke KPN can continue to grow EBIT at last year’s rate of 16% over last year, then it will find its debt more manageable. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Koninklijke KPN’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.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Koninklijke KPN has recorded free cash flow of 78% 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

When it comes to the balance sheet, the most notable positive for Koninklijke KPN is the fact that it seems able to convert EBIT into free cash flow with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. When considering all the above mentioned elements, it seems to us that Koninklijke KPN manages its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. 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. We have identified 3 warning signs with Koninklijke KPN, and understanding them should be part of your investment process.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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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