Sanstar (NSE:SANSTAR) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Sanstar Limited (NSE:SANSTAR) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, 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.

Check out our latest analysis for Sanstar

How Much Debt Does Sanstar Carry?

The image below, which you can click on for greater detail, shows that Sanstar had debt of ₹668.1m at the end of September 2024, a reduction from ₹1.28b over a year. But it also has ₹3.09b in cash to offset that, meaning it has ₹2.42b net cash.

A Look At Sanstar's Liabilities

We can see from the most recent balance sheet that Sanstar had liabilities of ₹846.5m falling due within a year, and liabilities of ₹555.4m due beyond that. On the other hand, it had cash of ₹3.09b and ₹919.6m worth of receivables due within a year. So it actually has ₹2.61b more liquid assets than total liabilities.

This short term liquidity is a sign that Sanstar could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Sanstar has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Sanstar grew its EBIT at 12% 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 you can't view debt in total isolation; since Sanstar 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. Sanstar 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, Sanstar saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sanstar has ₹2.42b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 12% over the last year. So we don't have any problem with Sanstar's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Sanstar that you should be aware of.

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.

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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.