The Net Debt/EBITDA ratio is rightly seen as an extremely important metric. Both investors and creditors employ the ratio to assess the company’s risks and financial capacity.
Net Debt/EBITDA, i.e., the ratio of net debt to earnings before interest, taxes, depreciation, and amortization, shows the level of financial leverage and whether the company can meet its obligations. Basically, it shows how long—approximately—the company needs to operate at the current level to pay off the entire debt. Rating agencies use this ratio to find out whether the company is prone not to meet its financial obligations.
Most companies maintain a fixed debt level for an indefinite period, as it’s a perfect tool to allocate capital the right way when used wisely.
All in all, if the market is stable, companies should be able to maintain sustainable debt levels as long as they can maintain acceptable profitability levels. A decent Net Debt/EBITDA metric says to investors that the company has a good level of financial leverage.
Net Debt/EBITDA is critical to:
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Net Debt = Short-term Debt + Long-term Debt − Cash and Cash Equivalents
We see the net debt as an indicator of a company’s financial independence. The lower the net debt, the fewer liabilities to creditors the company has. If short-term liabilities prevail, it increases the risk of financial instability, while long-term liabilities reduce this risk.
1. #INTC EBITDA for the accounting year ended in December 2020 totals:
EBITDA = Net Income + Taxes + Interest + Depreciation + Amortization = $20,899 + $4,179 + ($1,400) + ($10,482 + $1,757) = $35,917
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2. #INTC Net Debt for the accounting year ended in December 2020 totals:
Net Debt = Short-term Debt + Long-term Debt − Cash and Cash Equivalents = $2,504 + $33,897 + ($1,400) − ($5,865 + $2,292 + $15,738) = $12,506
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3. #INTC Net Debt/EBITDA or the accounting year ended in December 2020 totals:
Net Debt/EBITDA = $12,506 / $35,917 = 0.35
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Intel has a reasonable Net Debt/EBITDA ratio. Intel’s Net Debt/EBITDA of 0.35 is lower compared to its competitors in the semiconductor industry (1.03 on average).
4. Let’s compare Net Debt/EBITDA for semiconductor companies that are similar in terms of market capitalization:
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1. A low Net Debt/EBITDA is usually preferable: the company isn’t overly indebted and is expected to be able to pay off its debt obligations.
2. If the Net Debt/EBITDA ratio is high, the company has a heavy debt. Situations like that would downgrade its credit rating, so investors would need higher returns to offset the elevated risk of default.
3. If Net Debt/EBITDA is more than 3.5x, you should be careful and analyze all the data thoroughly. Net Debt/EBITDA that’s above 5x is seen as a red flag for rating agencies and investors. If the company has a heavy debt load, it can have a hard time meeting its obligations. For these companies, raising additional loans will be a severe challenge.
4. The ratio can be significantly adjusted for each industry, as each industry is different in terms of the average capital requirements. This means that you should use the ratio for comparison with peers within the same industry/sector. If you see debt levels above the industry average, keep your eyes peeled for that.
5. If you have a negative Net Debt/EBITDA value, the company may (not necessarily) be considered unstable—there’s no debt and no prospect of the company unlocking new markets or developing production facilities by using external financing sources.
6. To make sure the company can meet its debt obligations, loan agreements usually include covenants that set the range for Net Debt/EBITDA.
Why high Net Debt/EBITDA can be a red flag
The long-term debt is about deducting the principal payment from free cash flows and represents money that can’t be reinvested in the company or returned to shareholders as dividends or buybacks.
Therefore, if you try to value the company by using free cash flows, you must take into account the long-term debt, as this reduces the future cash flows that make up the intrinsic value of your investments.
Net Debt/EBITDA is perfect for benchmarking purposes within the same sector. Keep in mind that any company goes its own way in its industry, which will impact the cost of capital adjusted for many external factors: expected future growth, competitiveness, pricing in the market, and much more.
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