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 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 SecureKloud Technologies Limited (NSE:SECURKLOUD) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is SecureKloud Technologies's Debt?
The image below, which you can click on for greater detail, shows that SecureKloud Technologies had debt of ₹1.05b at the end of September 2022, a reduction from ₹1.39b over a year. On the flip side, it has ₹369.7m in cash leading to net debt of about ₹682.9m.
How Strong Is SecureKloud Technologies' Balance Sheet?
We can see from the most recent balance sheet that SecureKloud Technologies had liabilities of ₹1.64b falling due within a year, and liabilities of ₹431.7m due beyond that. Offsetting this, it had ₹369.7m in cash and ₹755.7m in receivables that were due within 12 months. So it has liabilities totalling ₹947.6m more than its cash and near-term receivables, combined.
This deficit isn't so bad because SecureKloud Technologies is worth ₹2.27b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. 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.
In the last year SecureKloud Technologies wasn't profitable at an EBIT level, but managed to grow its revenue by 23%, to ₹4.3b. With any luck the company will be able to grow its way to profitability.
Even though SecureKloud Technologies managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable ₹1.1b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled ₹763m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with SecureKloud Technologies (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.
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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