The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that ExlService Holdings, Inc. (NASDAQ:EXLS) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is ExlService Holdings’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that ExlService Holdings had US$244.8m of debt in September 2019, down from US$300.6m, one year before. However, it does have US$280.8m in cash offsetting this, leading to net cash of US$36.0m.
How Strong Is ExlService Holdings’s Balance Sheet?
According to the last reported balance sheet, ExlService Holdings had liabilities of US$187.9m due within 12 months, and liabilities of US$310.4m due beyond 12 months. Offsetting this, it had US$280.8m in cash and US$197.4m in receivables that were due within 12 months. So it has liabilities totalling US$20.1m more than its cash and near-term receivables, combined.
Having regard to ExlService Holdings’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$2.54b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, ExlService Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!
Also good is that ExlService Holdings grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ExlService Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ExlService Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, ExlService Holdings actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that ExlService Holdings has US$36.0m in net cash. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in US$108m. So we don’t think ExlService Holdings’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 1 warning sign for ExlService Holdings that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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