Warren Buffett famously said, '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. We note that TAKE Solutions Limited (NSE:TAKE) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does TAKE Solutions Carry?
The image below, which you can click on for greater detail, shows that at March 2019 TAKE Solutions had debt of ₹4.74b, up from ₹3.23b in one year. However, because it has a cash reserve of ₹2.50b, its net debt is less, at about ₹2.23b.
How Healthy Is TAKE Solutions's Balance Sheet?
The latest balance sheet data shows that TAKE Solutions had liabilities of ₹7.24b due within a year, and liabilities of ₹827.6m falling due after that. Offsetting these obligations, it had cash of ₹2.50b as well as receivables valued at ₹7.11b due within 12 months. So it can boast ₹1.55b more liquid assets than total liabilities.
This short term liquidity is a sign that TAKE Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched.
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.
TAKE Solutions has a low net debt to EBITDA ratio of only 0.75. And its EBIT covers its interest expense a whopping 14.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that TAKE Solutions has increased its EBIT by 8.5% over twelve months, which should ease any concerns about debt repayment. 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 TAKE Solutions'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, TAKE Solutions burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Happily, TAKE Solutions's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. We would also note that Healthcare Services industry companies like TAKE Solutions commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that TAKE Solutions can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that TAKE Solutions insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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