Allied Digital Services (NSE:ADSL) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Allied Digital Services Limited (NSE:ADSL) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Allied Digital Services

What Is Allied Digital Services's Net Debt?

As you can see below, Allied Digital Services had ₹425.6m of debt at March 2022, down from ₹525.4m a year prior. However, its balance sheet shows it holds ₹591.4m in cash, so it actually has ₹165.8m net cash.

How Healthy Is Allied Digital Services' Balance Sheet?

According to the last reported balance sheet, Allied Digital Services had liabilities of ₹1.05b due within 12 months, and liabilities of ₹317.8m due beyond 12 months. Offsetting this, it had ₹591.4m in cash and ₹2.01b in receivables that were due within 12 months. So it actually has ₹1.23b more liquid assets than total liabilities.

This excess liquidity suggests that Allied Digital Services is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Allied Digital Services has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Allied Digital Services grew its EBIT by 113% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Allied Digital 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. Allied Digital Services 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, Allied Digital Services produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Allied Digital Services has net cash of ₹165.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 113% over the last year. So we don't think Allied Digital Services's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Allied Digital Services you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.