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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Intellect Design Arena Limited (NSE:INTELLECT) makes use of 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Intellect Design Arena Carry?
As you can see below, Intellect Design Arena had ₹1.01b of debt at March 2019, down from ₹1.29b a year prior. However, it does have ₹5.19b in cash offsetting this, leading to net cash of ₹4.18b.
A Look At Intellect Design Arena's Liabilities
Zooming in on the latest balance sheet data, we can see that Intellect Design Arena had liabilities of ₹5.36b due within 12 months and liabilities of ₹661.3m due beyond that. Offsetting these obligations, it had cash of ₹5.19b as well as receivables valued at ₹6.28b due within 12 months. So it actually has ₹5.44b more liquid assets than total liabilities.
This excess liquidity suggests that Intellect Design Arena is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Intellect Design Arena has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Intellect Design Arena grew its EBIT by 96% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Intellect Design Arena'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Intellect Design Arena may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last two years, Intellect Design Arena burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Intellect Design Arena has net cash of ₹4.2b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 96% over the last year. So we don't have any problem with Intellect Design Arena's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Intellect Design Arena insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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