Genpact (NYSE:G) Has A Pretty Healthy Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Genpact Limited (NYSE:G) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Genpact

What Is Genpact's Debt?

As you can see below, at the end of December 2020, Genpact had US$1.59b of debt, up from US$1.44b a year ago. Click the image for more detail. However, because it has a cash reserve of US$689.2m, its net debt is less, at about US$901.7m.

How Strong Is Genpact's Balance Sheet?

According to the last reported balance sheet, Genpact had liabilities of US$1.20b due within 12 months, and liabilities of US$1.84b due beyond 12 months. Offsetting these obligations, it had cash of US$689.2m as well as receivables valued at US$890.1m due within 12 months. So its liabilities total US$1.46b more than the combination of its cash and short-term receivables.

Given Genpact has a market capitalization of US$8.15b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Genpact has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.8 times, which is more than adequate. Also good is that Genpact grew its EBIT at 18% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Genpact's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Genpact recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Genpact's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its interest cover is also very heartening. Looking at the bigger picture, we think Genpact's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. For example, we've discovered 2 warning signs for Genpact that you should be aware of before investing here.

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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