Stock Analysis

Here's Why FCS Software Solutions (NSE:FCSSOFT) Has A Meaningful Debt Burden

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that FCS Software Solutions Limited (NSE:FCSSOFT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for FCS Software Solutions

What Is FCS Software Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that FCS Software Solutions had debt of ₹203.0m at the end of September 2022, a reduction from ₹241.0m over a year. However, it also had ₹66.1m in cash, and so its net debt is ₹137.0m.

NSEI:FCSSOFT Debt to Equity History March 17th 2023

How Healthy Is FCS Software Solutions' Balance Sheet?

We can see from the most recent balance sheet that FCS Software Solutions had liabilities of ₹161.1m falling due within a year, and liabilities of ₹192.6m due beyond that. On the other hand, it had cash of ₹66.1m and ₹59.9m worth of receivables due within a year. So it has liabilities totalling ₹227.8m more than its cash and near-term receivables, combined.

Given FCS Software Solutions has a market capitalization of ₹3.59b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

FCS Software Solutions's net debt of 2.2 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.3 times its interest expenses harmonizes with that theme. We also note that FCS Software Solutions improved its EBIT from a last year's loss to a positive ₹29m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since FCS Software Solutions 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, FCS Software Solutions 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.

Our View

FCS Software Solutions'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. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. Looking at all the angles mentioned above, it does seem to us that FCS Software Solutions is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that FCS Software Solutions is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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