Is Allied Digital Services (NSE:ADSL) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Allied Digital Services Limited (NSE:ADSL) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Allied Digital Services

What Is Allied Digital Services's Net Debt?

As you can see below, Allied Digital Services had ₹528.2m of debt at September 2021, down from ₹619.5m a year prior. But on the other hand it also has ₹598.0m in cash, leading to a ₹69.8m net cash position.

A Look At Allied Digital Services' Liabilities

We can see from the most recent balance sheet that Allied Digital Services had liabilities of ₹1.24b falling due within a year, and liabilities of ₹291.8m due beyond that. Offsetting these obligations, it had cash of ₹598.0m as well as receivables valued at ₹1.99b due within 12 months. So it actually has ₹1.06b more liquid assets than total liabilities.

It's good to see that Allied Digital Services has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face 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.

On top of that, Allied Digital Services grew its EBIT by 68% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Allied Digital Services has net cash of ₹69.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in -₹27m. When it comes to Allied Digital Services's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Case in point: We've spotted 5 warning signs for Allied Digital Services you should be aware of.

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.