Is Sterlite Technologies (NSE: STLTECH) using too much debt?
Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Sterlite Technologies Limited (NSE: STLTECH) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first look at cash and debt levels together.
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What is the debt of Sterlite Technologies?
The graph below, which you can click for more details, shows that Sterlite Technologies had â¬ 24.9 billion in debt in March 2021; about the same as the year before. However, it has 4.57 billion yen in cash offsetting this, which leads to net debt of around 20.3 billion yen.
How strong is Sterlite Technologies’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Sterlite Technologies had a liability of 44.7 billion yen due within 12 months and a liability of 15.2 billion yen beyond. In return, he had 4.57 billion yen in cash and 27.8 billion yen in receivables due within 12 months. Thus, its liabilities exceed the sum of its cash and its (short-term) receivables by 27.5 billion euros.
Sterlite Technologies has a market capitalization of 111.6 billion yen, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Sterlite Technologies’ net debt stands at a very reasonable level of 2.4 times its EBITDA, while its EBIT only covered its interest expense 2.9 times last year. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. It is important to note that Sterlite Technologies’ EBIT has fallen by 30% over the past twelve months. If this decline continues, it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Sterlite Technologies’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Sterlite Technologies has created a free cash flow of 11% of its EBIT, a performance without interest. For us, the conversion to cash that elicits a bit of paranoia is the ability to extinguish debt.
Our point of view
We would go so far as to say that Sterlite Technologies’ EBIT growth rate was disappointing. That said, his ability to manage his total liabilities isn’t that much of a concern. Overall, we think it’s fair to say that Sterlite Technologies has enough debt that there is real risk around the balance sheet. If all goes well, it may pay off, but the downside to this debt is an increased risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 5 warning signs for Sterlite Technologies you should be aware of it, and one of them doesn’t suit us very well.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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