Mastek (NSE:MASTEK) Could Easily Take On More Debt
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. We can see that Mastek Limited (NSE:MASTEK) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Mastek
What Is Mastek's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Mastek had debt of ₹667.5m, up from ₹41.4m in one year. However, it does have ₹2.64b in cash offsetting this, leading to net cash of ₹1.97b.
How Healthy Is Mastek's Balance Sheet?
We can see from the most recent balance sheet that Mastek had liabilities of ₹1.59b falling due within a year, and liabilities of ₹1.01b due beyond that. Offsetting this, it had ₹2.64b in cash and ₹2.17b in receivables that were due within 12 months. So it actually has ₹2.22b more liquid assets than total liabilities.
This surplus suggests that Mastek is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Mastek has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Mastek grew its EBIT at 12% 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 Mastek 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Mastek has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Mastek recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Mastek has net cash of ₹1.97b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 12% in the last twelve months. So we don't think Mastek's use of debt is risky. We'd be very excited to see if Mastek insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
