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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies. Sify Technologies Limited (NASDAQ:SIFY) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Sify Technologies Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Sify Technologies had ₹8.31b of debt, an increase on ₹5.79b, over one year. However, it also had ₹1.93b in cash, and so its net debt is ₹6.37b.
A Look At Sify Technologies’s Liabilities
The latest balance sheet data shows that Sify Technologies had liabilities of ₹14.4b due within a year, and liabilities of ₹4.72b falling due after that. On the other hand, it had cash of ₹1.93b and ₹10.0b worth of receivables due within a year. So it has liabilities totalling ₹7.18b more than its cash and near-term receivables, combined.
Sify Technologies has a market capitalization of ₹14.5b, so it could very likely ameliorate its balance sheet if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. Because it carries more debt than cash, we think it’s worth watching Sify Technologies’s balance sheet over time.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Sify Technologies has net debt worth 2.05 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 2.99 times the interest expense. While that doesn’t worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Sify Technologies grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sify Technologies can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sify Technologies saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Sify Technologies’s conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Sify Technologies is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn’t really want to see it increase from here. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Sify Technologies’s earnings per share history for free.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.