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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Kellton Tech Solutions Limited (NSE:KELLTONTEC) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Kellton Tech Solutions
How Much Debt Does Kellton Tech Solutions Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Kellton Tech Solutions had ₹1.23b of debt, an increase on ₹1.14b, over one year. However, it also had ₹1.11b in cash, and so its net debt is ₹123.0m.
How Strong Is Kellton Tech Solutions's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kellton Tech Solutions had liabilities of ₹2.08b due within 12 months and liabilities of ₹622.6m due beyond that. Offsetting this, it had ₹1.11b in cash and ₹1.80b in receivables that were due within 12 months. So it can boast ₹216.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Kellton Tech Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched. Either way, since Kellton Tech Solutions does have more debt than cash, it's worth keeping an eye on its balance sheet.
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.
While Kellton Tech Solutions's low debt to EBITDA ratio of 0.11 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.89 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Sadly, Kellton Tech Solutions's EBIT actually dropped 3.1% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kellton Tech 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Kellton Tech Solutions recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
Kellton Tech Solutions's net debt to EBITDA was a real positive on this analysis, as was its level of total liabilities. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Kellton Tech Solutions is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Kellton Tech Solutions's earnings per share history for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.