Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Sify Technologies Limited (NASDAQ:SIFY) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Sify Technologies Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Sify Technologies had debt of ₹8.21b, up from ₹6.61b in one year. However, it also had ₹1.93b in cash, and so its net debt is ₹6.28b.
A Look At Sify Technologies's Liabilities
According to the last reported balance sheet, Sify Technologies had liabilities of ₹14.4b due within 12 months, and liabilities of ₹4.72b due beyond 12 months. On the other hand, it had cash of ₹1.93b and ₹10.0b worth of receivables due within a year. So it has liabilities totalling ₹7.18b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Sify Technologies is worth ₹13.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Sify Technologies has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.0 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We note that Sify Technologies grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sify Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Sify Technologies burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Sify Technologies's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its EBIT growth rate was re-invigorating. When we consider all the factors discussed, it seems to us that Sify Technologies is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Over time, share prices tend to follow earnings per share, so if you're interested in Sify Technologies, you may well want to click here to check an interactive graph of its earnings per share history.
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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