Over the past few weeks I have been watching the developments of the telecommunications industry, which has provided an excellent opportunity to search for investment stocks in this sector. One company I think is very interesting to analyze is Sprint Corp Series 1(NYSE:S). While there are many different factors to consider when investing, in the article below I will look at the debt side of the company. I will analyze Sprint's debt ratios and what analysts and other top investors think about the company, which should give us an idea of the company’s leverage and how much to expect in return for investing in it over the long term.
As the third largest mobile carrier in the U.S., Sprint serves 47 million customers directly and another 8 million via affiliates. However, the recent years have proven difficult for the firm, with its postpaid market share plummeting from an initial 21% to 14%. Competing against AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ), the firm’s postpaid base was 75% of the size of these rivals in 2007, but now it’s only half as big. Although the carrier has recovered somewhat from 2009’s historical low point, it still has a long way to go. In the hopes of expanding its scale, Sprint acquired Clearwire in July 2013, and is now undergoing a network modernization project, in order to integrate the purchase and rebuild momentum. Although this measure is surely necessary to keep growing, Sprint’s position as the most leveraged U.S. mobile carrier makes it particularly vulnerable to any errors.
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It is essential to remark that gaining knowledge about Sprint’s debt and liabilities is a key component in understanding the risk of investing in this company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. By studying the debt part of Sprint, the investor will discover if the firm is able to keep its capital and use it for growth in the future. While the Japanese wireless carrier Softbank took a 78% stake in the company, giving it new capital to expand its competitive position, Sprint’s addition of the Network Vision upgrade to its core network, in addition to the Clearwater integration, have increased capital spending substantially over the past quarters and the trend is not likely to be reverted soon.
Total Debt to Total Assets Ratio
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing this figure by the company's total assets. A debt ratio greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio below 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, this ratio can help investors determine a company's level of risk.
Sprint's total debt to total assets ratio has been shrinking over the past three years, from 0.40 to 0.37. This means that, since 2010, the company has increased the value of its assets at a faster pace than its debt levels, which certainly proves management’s commitment with reducing debt levels. Given that the carrier’s ratio of 0.37 is below 1, the financial risk faced by the company is relatively low, as its assets’ value comfortably surpasses its total debt levels.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity, but if the ratio is above 0.5, then the company's assets are likely financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged", meaning they could be in danger if creditors start to demand repayment of debt.
When looking at Sprint's total liabilities to total assets ratio over the past three years, we can see that it has, in fact, diminished from 0.77 to 0.70. I usually like to see the debt side of a company’s balance sheet shrink, so this trend is definitely encouraging. However, despite a drop in the firm’s debt ratio, 2013’s TTM ratio surpasses the 0.50 mark, indicating that most of the company´s assets are financed through debt.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that measures how much suppliers, lenders, creditors and obligators have committed to the company, versus what the shareholders have committed. A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, which can result in the company reporting volatile earnings. It also indicates that a company is unable to generate enough cash to satisfy its debt obligations, and is therefore considered a riskier investment.
Sprint's debt-to-equity ratio has fallen over the past three years. In 2013, it acquired a value of 2.36, compared to 3.31 in 2011. This is an encouraging sign, as it shows that the company has ameliorated its balance sheet and risk profile. However, the company’s ratio of 2.36 still vastly surpasses 1, implying that the company faces high risks, and so do its investors. When analyzed, this figure entails that shareholders have invested more than suppliers, lenders, creditors and obligators.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which a company is using its equity to support operations and growth. Companies with a high capitalization ratio are considered to be risky: if they fail to repay their debt on time, jeopardy of insolvency can increase. Companies with an elevated capitalization ratio may also find it difficult to get more loans in the future.
Since 2011, Sprint's capitalization ratio has decreased from 0.64 to 0.55, in 2013. Showing a boost in equity compared to the company’s long-term debt. We can also assume that this elevated equity has served to the purpose of supporting operations and growth. Furthermore, a reduction in this ratio implies a smaller financial risk for the company and its investors.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. It provides an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions.
As Sprint’s ratio currently stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. I assume that if a prominent institutional investor put money into Sprint’s stock, it will pass strict fundamental standards. So, last quarter, both Leon Cooperman (Trades, Portfolio) and John Paulson (Trades, Portfolio) among other prominent investors bought the carrier’s shares at an average price of $8.38.
Several analysts expect Sprint to perform well over the upcoming years. Analysts at Bloomberg, for example, estimate that the firm’s revenue will reach $35.03B for the current fiscal year and $35.45B for the next one. Also, on 21/02/2014, Deutsche Bank gave Sprint a rating of "Buy" with a target price of $7.28, implying significant upside potential from this point.
Although the company maintains its position as the most leveraged U.S. mobile carrier, with its debt levels and ratios strongly surpassing those of Verizon and AT&T, I believe the next few years could show a turnaround for Sprint. The rise in debt levels seem to mainly attributable to the Clearwater acquisition and restructuring efforts on behalf of management, which are all necessary in order to regain the customers lost over the past years.
There’s no doubt that Sprint operates in a much weaker competitive position than its industry rivals, but I think the long term will remount this carriers profitability for investors. Once Network Vision and Clearwater are fully integrated, margins should see a significant boost and the company’s scale should continue to expand over time. However, I do advise caution and would recommend potential shareholders to await next quarter’s earnings report before making a final decision.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.