Is Adroit Infotech (NSE:ADROITINFO) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Adroit Infotech Limited (NSE:ADROITINFO) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Adroit Infotech

What Is Adroit Infotech's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Adroit Infotech had debt of ₹146.0m, up from ₹22.0m in one year. However, because it has a cash reserve of ₹14.0m, its net debt is less, at about ₹132.1m.

A Look At Adroit Infotech's Liabilities

The latest balance sheet data shows that Adroit Infotech had liabilities of ₹174.5m due within a year, and liabilities of ₹23.1m falling due after that. Offsetting this, it had ₹14.0m in cash and ₹151.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹32.0m.

Since publicly traded Adroit Infotech shares are worth a total of ₹1.01b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Adroit Infotech's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its commanding EBIT of 10.7 times its interest expense, implies the debt load is as light as a peacock feather. We also note that Adroit Infotech improved its EBIT from a last year's loss to a positive ₹46m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Adroit Infotech will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last year, Adroit Infotech burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Adroit Infotech's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its interest cover was refreshing. Looking at all the angles mentioned above, it does seem to us that Adroit Infotech 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. Case in point: We've spotted 5 warning signs for Adroit Infotech you should be aware of, and 3 of them are concerning.

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. 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.