Howard Marks put it nicely when he said that, rather than worrying about stock price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when examining how risky it is, since debt is often involved when a business fails. We notice that Tech Mahindra Limited (NSE:TECHM) has debt on its balance sheet. But should shareholders be concerned about his use of debt?
When is debt a problem?
In general, debt only becomes a real problem when a company cannot easily pay it off, either through capital raising or its own cash flow. Ultimately, if the company can’t meet its legal debt repayment obligations, shareholders could walk away with nothing. However, the more common (but still painful) scenario is that it has to raise new equity capital at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance growth, without any negative consequences. The first step when considering a company’s debt level is to consider its cash and debt together.
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How much debt is Tech Mahindra carrying?
The figure below, which you can click on for more details, shows that Tech Mahindra had a debt of INR 16.8 billion in September 2022, up from INR 15.3 billion a year earlier. But on the other hand, it also has INR 72.5 billion in cash, leading to a net cash position of INR 55.7 billion.
How healthy is Tech Mahindra’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Tech Mahindra had liabilities of INR 139.9 billion due within 12 months and liabilities of INR 44.2 billion due thereafter. On the other hand, it had cash of ₹ 72.5 billion and ₹ 124.6 billion worth of receivables due within a year. So it boasts INR 13.0 billion more liquid assets than in total liabilities, debts.
This state of affairs indicates that Tech Mahindra’s balance sheet looks quite solid, as its total liabilities are roughly equal to its liquid assets. So while it’s hard to imagine the INR 916.7 billion company struggling for cash, we still think its balance sheet is worth keeping an eye on. In short, Tech Mahindra boasts of net cash, so it’s fair to say that it doesn’t have a huge debt load!
But the other side of the story is that Tech Mahindra saw its EBIT decline by 2.2% over the past year. If earnings continue to decline at that rate, the company may have increasing difficulty managing its debt burden. There is no doubt that we learn the most about debt from the balance sheet. But ultimately the future profitability of the business will decide whether Tech Mahindra can strengthen its balance sheet over time. So if you want to see what the pros think, this free analyst profit forecast report might be of interest.
Finally, the company can only pay off the debt with cold hard cash, not accounting profit. Tech Mahindra may have net cash on its balance sheet, but it’s still interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will affect both its need and capacity to manage debt. Over the last three years, Tech Mahindra has generated free cash flow of a very robust 100% of its EBIT, more than we would have expected. This puts him in a very strong position to repay the debt.
While it is always prudent to investigate a company’s debt, in this case Tech Mahindra has INR 55.7 billion in net cash and a decent balance sheet. And it impressed us with a free cash flow of INR 43 billion, which is 100% of its EBIT. So, is Tech Mahindra’s debt a risk? It doesn’t seem like that to us. The balance sheet is obviously an area to focus on when analyzing debt. But ultimately, any business can contain risks that exist off the balance sheet. For example, we identified 1 warning sign for Tech Mahindra you should be aware of that.
If, after all that, you’re more interested in a fast-growing company with a solid balance sheet, then take a look at our list of net cash growth stocks without delay.
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This Simply Wall St article 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 into account your goals or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simpli Wall St has no position in any of the stocks mentioned.