Is Yaarii Digital Integrated Services (NSE:YAARII) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Yaarii Digital Integrated Services Limited (NSE:YAARII) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Yaarii Digital Integrated Services

What Is Yaarii Digital Integrated Services's Debt?

You can click the graphic below for the historical numbers, but it shows that Yaarii Digital Integrated Services had ₹8.19b of debt in September 2020, down from ₹14.6b, one year before. However, because it has a cash reserve of ₹3.28b, its net debt is less, at about ₹4.91b.

How Healthy Is Yaarii Digital Integrated Services' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yaarii Digital Integrated Services had liabilities of ₹12.3b due within 12 months and liabilities of ₹882.7m due beyond that. Offsetting this, it had ₹3.28b in cash and ₹3.12b in receivables that were due within 12 months. So it has liabilities totalling ₹6.83b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹9.79b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Yaarii Digital Integrated Services's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 0.98, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. One redeeming factor for Yaarii Digital Integrated Services is that it turned last year's EBIT loss into a gain of ₹1.4b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yaarii Digital Integrated Services will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Yaarii Digital Integrated Services actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Yaarii Digital Integrated Services's interest cover and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Yaarii Digital Integrated Services is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Yaarii Digital Integrated Services (of which 1 makes us a bit uncomfortable!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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