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 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 Yaarii Digital Integrated Services Limited (NSE:YAARII) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Yaarii Digital Integrated Services

What Is Yaarii Digital Integrated Services's Net Debt?

The image below, which you can click on for greater detail, shows that Yaarii Digital Integrated Services had debt of ₹8.87b at the end of September 2021, a reduction from ₹12.6b over a year. On the flip side, it has ₹334.2m in cash leading to net debt of about ₹8.54b.

A Look At Yaarii Digital Integrated Services' Liabilities

The latest balance sheet data shows that Yaarii Digital Integrated Services had liabilities of ₹8.86b due within a year, and liabilities of ₹668.4m falling due after that. On the other hand, it had cash of ₹334.2m and ₹3.55b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.64b.

This is a mountain of leverage relative to its market capitalization of ₹8.41b. 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).

Yaarii Digital Integrated Services shareholders face the double whammy of a high net debt to EBITDA ratio (27.8), and fairly weak interest coverage, since EBIT is just 0.09 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Yaarii Digital Integrated Services's EBIT was down 94% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, Yaarii Digital Integrated Services actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Yaarii Digital Integrated Services's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that Yaarii Digital Integrated Services's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Yaarii Digital Integrated Services that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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