Here's Why Tech Mahindra (NSE:TECHM) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Tech Mahindra Limited (NSE:TECHM) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tech Mahindra

How Much Debt Does Tech Mahindra Carry?

The image below, which you can click on for greater detail, shows that Tech Mahindra had debt of ₹26.1b at the end of September 2023, a reduction from ₹28.3b over a year. However, it does have ₹61.2b in cash offsetting this, leading to net cash of ₹35.0b.

A Look At Tech Mahindra's Liabilities

The latest balance sheet data shows that Tech Mahindra had liabilities of ₹128.0b due within a year, and liabilities of ₹38.4b falling due after that. Offsetting these obligations, it had cash of ₹61.2b as well as receivables valued at ₹120.6b due within 12 months. So it can boast ₹15.4b more liquid assets than total liabilities.

Having regard to Tech Mahindra's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹1.11t company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Tech Mahindra has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Tech Mahindra's saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tech Mahindra can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tech Mahindra has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Tech Mahindra recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tech Mahindra has net cash of ₹35.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in ₹44b. So we are not troubled with Tech Mahindra's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Tech Mahindra that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.