Stock Analysis

Tech Mahindra (NSE:TECHM) Seems To Use Debt Quite Sensibly

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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. Importantly, Tech Mahindra Limited (NSE:TECHM) does carry debt. 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 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. When we think about a company's use of debt, we first look at cash and debt together.

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What Is Tech Mahindra's Net Debt?

As you can see below, at the end of September 2022, Tech Mahindra had ₹28.3b of debt, up from ₹26.1b a year ago. Click the image for more detail. But it also has ₹72.5b in cash to offset that, meaning it has ₹44.2b net cash.

NSEI:TECHM Debt to Equity History February 20th 2023

A Look At Tech Mahindra's Liabilities

The latest balance sheet data shows that Tech Mahindra had liabilities of ₹139.9b due within a year, and liabilities of ₹44.2b falling due after that. On the other hand, it had cash of ₹72.5b and ₹124.6b worth of receivables due within a year. So it actually has ₹13.0b 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 ₹993.4b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Tech Mahindra boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Tech Mahindra saw its EBIT decline by 5.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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. During the last three years, Tech Mahindra generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tech Mahindra has ₹44.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹43b, being 94% of its EBIT. So we don't think Tech Mahindra's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Tech Mahindra you should know about.

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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