Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Wipro Limited (NSE:WIPRO) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Wipro’s Debt?
The image below, which you can click on for greater detail, shows that Wipro had debt of ₹94.7b at the end of December 2019, a reduction from ₹101.5b over a year. But on the other hand it also has ₹352.3b in cash, leading to a ₹257.6b net cash position.
How Healthy Is Wipro’s Balance Sheet?
The latest balance sheet data shows that Wipro had liabilities of ₹215.8b due within a year, and liabilities of ₹54.2b falling due after that. On the other hand, it had cash of ₹352.3b and ₹157.2b worth of receivables due within a year. So it can boast ₹239.5b more liquid assets than total liabilities.
This excess liquidity suggests that Wipro is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don’t think it will have any issues with its lenders. Simply put, the fact that Wipro has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Wipro has been able to increase its EBIT by 24% in twelve months, making it easier to pay down 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 Wipro 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, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. Wipro 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. Over the last three years, Wipro recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Wipro has net cash of ₹257.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in ₹97b. So we don’t think Wipro’s use of debt is risky. We’d be very excited to see if Wipro insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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