SecureKloud Technologies (NSE:SECURKLOUD) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, SecureKloud Technologies Limited (NSE:SECURKLOUD) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SecureKloud Technologies

How Much Debt Does SecureKloud Technologies Carry?

As you can see below, at the end of March 2021, SecureKloud Technologies had ₹1.38b of debt, up from ₹1.18b a year ago. Click the image for more detail. However, it also had ₹437.2m in cash, and so its net debt is ₹944.0m.

How Strong Is SecureKloud Technologies' Balance Sheet?

We can see from the most recent balance sheet that SecureKloud Technologies had liabilities of ₹1.62b falling due within a year, and liabilities of ₹650.2m due beyond that. Offsetting these obligations, it had cash of ₹437.2m as well as receivables valued at ₹551.5m due within 12 months. So it has liabilities totalling ₹1.28b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since SecureKloud Technologies has a market capitalization of ₹3.12b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about SecureKloud Technologies's net debt to EBITDA ratio of 2.9, we think its super-low interest cover of 1.2 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, the silver lining was that SecureKloud Technologies achieved a positive EBIT of ₹145m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SecureKloud Technologies will need earnings to service that debt. 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, SecureKloud Technologies recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

SecureKloud Technologies's struggle to cover its interest expense with its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its EBIT growth rate is relatively strong. When we consider all the factors discussed, it seems to us that SecureKloud Technologies is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with SecureKloud Technologies (including 1 which makes us a bit uncomfortable) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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