Is Trejhara Solutions (NSE:TREJHARA) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Trejhara Solutions Limited (NSE:TREJHARA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Trejhara Solutions

What Is Trejhara Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that Trejhara Solutions had debt of ₹265.9m at the end of March 2021, a reduction from ₹336.5m over a year. However, it also had ₹58.7m in cash, and so its net debt is ₹207.1m.

A Look At Trejhara Solutions' Liabilities

According to the last reported balance sheet, Trejhara Solutions had liabilities of ₹908.5m due within 12 months, and liabilities of ₹303.5m due beyond 12 months. On the other hand, it had cash of ₹58.7m and ₹234.4m worth of receivables due within a year. So its liabilities total ₹918.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₹742.1m, we think shareholders really should watch Trejhara Solutions's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.4 and interest cover of 6.8 times, it seems to us that Trejhara Solutions is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. In addition to that, we're happy to report that Trejhara Solutions has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Trejhara 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Trejhara Solutions generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Both Trejhara Solutions's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. Considering this range of data points, we think Trejhara Solutions is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for Trejhara Solutions (of which 2 shouldn't be ignored!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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. 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.
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