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.' 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 note that Hinduja Global Solutions Limited (NSE:HGS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Hinduja Global Solutions's Net Debt?
As you can see below, Hinduja Global Solutions had ₹2.92b of debt at March 2021, down from ₹6.04b a year prior. But on the other hand it also has ₹5.89b in cash, leading to a ₹2.96b net cash position.
How Healthy Is Hinduja Global Solutions' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hinduja Global Solutions had liabilities of ₹11.8b due within 12 months and liabilities of ₹10.8b due beyond that. Offsetting this, it had ₹5.89b in cash and ₹17.5b in receivables that were due within 12 months. So it actually has ₹799.8m more liquid assets than total liabilities.
This state of affairs indicates that Hinduja Global Solutions' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹60.8b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Hinduja Global Solutions has more cash than debt is arguably a good indication that it can manage its debt safely.
We note that Hinduja Global Solutions grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Hinduja Global Solutions's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hinduja Global Solutions 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, Hinduja Global Solutions actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Hinduja Global Solutions has ₹2.96b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 117% of that EBIT to free cash flow, bringing in ₹5.3b. So is Hinduja Global Solutions's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Hinduja Global Solutions that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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