Quess (NSE:QUESS) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Quess Corp Limited (NSE:QUESS) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Quess

What Is Quess's Debt?

As you can see below, Quess had ₹4.70b of debt at September 2020, down from ₹12.2b a year prior. However, it does have ₹5.78b in cash offsetting this, leading to net cash of ₹1.09b.

How Healthy Is Quess' Balance Sheet?

According to the last reported balance sheet, Quess had liabilities of ₹17.7b due within 12 months, and liabilities of ₹6.54b due beyond 12 months. On the other hand, it had cash of ₹5.78b and ₹18.8b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Quess' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹101.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Quess boasts net cash, so it's fair to say it does not have a heavy debt load!

Sadly, Quess's EBIT actually dropped 10.0% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Quess 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Quess 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. During the last three years, Quess generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Quess has ₹1.09b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in ₹5.7b. So we don't have any problem with Quess's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Quess has 2 warning signs we think you should be aware of.

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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