Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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. Above all, Kellton Tech Solutions Limited (NSE: KELLTONTEC) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. 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 look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Kellton Tech Solutions
How much debt does Kellton Tech Solutions have?
The image below, which you can click on for more details, shows that Kellton Tech Solutions had debt of ₹959.8m at the end of September 2021, a reduction from ₹1.16bn year on year . However, he has ₹298.6 million in cash to offset this, resulting in a net debt of around ₹661.2 million.
A Look at Kellton Tech Solutions’ Responsibilities
According to the latest published balance sheet, Kellton Tech Solutions had liabilities of ₹1.63 billion due within 12 months and liabilities of ₹375.4 million due beyond 12 months. As compensation for these obligations, it had cash of ₹298.6 million as well as receivables valued at ₹2.25 billion due within 12 months. He can therefore boast of having ₹550.3 million more liquid assets than total Passives.
This short-term liquidity is a sign that Kellton Tech Solutions could probably service its debt easily, as its balance sheet is far from stretched.
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Kellton Tech Solutions has a low net debt to EBITDA ratio of just 0.60. And its EBIT covers its interest charges 14.1 times. So we’re pretty relaxed about his super-conservative use of debt. Another good thing is that Kellton Tech Solutions grew its EBIT by 16% over the past year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But it’s Kellton Tech Solutions’ earnings that will influence the balance sheet going forward. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Kellton Tech Solutions’ free cash flow has been 34% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.
Our point of view
The good news is that Kellton Tech Solutions’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. When we consider the range of factors above, it appears that Kellton Tech Solutions is quite sensitive with its use of debt. This means they take on a bit more risk, hoping to increase shareholder returns. 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. For example, we found 1 warning sign for Kellton Tech Solutions which you should be aware of before investing here.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% free, at present.
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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 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.