These 4 Measures Indicate That ExlService Holdings (NASDAQ:EXLS) Is Using Debt Safely

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, ExlService Holdings, Inc. (NASDAQ:EXLS) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for ExlService Holdings

What Is ExlService Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 ExlService Holdings had debt of US$285.0m, up from US$154.4m in one year. However, it also had US$265.2m in cash, and so its net debt is US$19.8m.

How Strong Is ExlService Holdings' Balance Sheet?

According to the last reported balance sheet, ExlService Holdings had liabilities of US$266.0m due within 12 months, and liabilities of US$339.3m due beyond 12 months. On the other hand, it had cash of US$265.2m and US$252.3m worth of receivables due within a year. So its liabilities total US$87.8m more than the combination of its cash and short-term receivables.

Having regard to ExlService Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$5.64b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, ExlService Holdings has a very light debt load indeed.

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.

ExlService Holdings has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.091 and EBIT of 131 times the interest expense. So relative to past earnings, the debt load seems trivial. Also good is that ExlService Holdings grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ExlService Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, ExlService Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that ExlService Holdings's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think ExlService Holdings is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of ExlService Holdings's earnings per share history for free.

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. 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.