These 4 metrics indicate that Tata Communications (NSE:TATACOMM) is using debt reasonably well

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Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Tata Communications Limited (NSE:TATACOMM) has debt on its balance sheet. But does this debt worry shareholders?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, 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, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Tata Communications

How much debt does Tata Communications have?

You can click on the chart below for historical figures, but it shows Tata Communications had ₹91.3 billion in debt in March 2022, up from ₹114.3 billion a year before. However, since it has a cash reserve of ₹11.3 billion, its net debt is lower at around ₹80.0 billion.

NSEI: TATACOMM Debt to Equity September 6, 2022

How strong is Tata Communications’ balance sheet?

The latest balance sheet data shows that Tata Communications had liabilities of ₹84.3 billion due within a year, and liabilities of ₹102.8 billion falling due thereafter. As compensation for these obligations, it had cash of ₹11.3 billion as well as receivables valued at ₹28.9 billion due within 12 months. It therefore has liabilities totaling ₹146.9 billion more than its cash and short-term receivables, combined.

This shortfall is not that bad as Tata Communications is worth ₹360.4 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Tata Communications’ net debt to EBITDA ratio of around 2.1 suggests only moderate use of debt. And its towering EBIT of 17.1 times its interest expense means that the debt burden is as light as a peacock feather. Tata Communications has increased its EBIT by 8.2% over the past year. While that barely brings us down, it’s a positive when it comes to debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Tata Communications can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Luckily for all shareholders, Tata Communications has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

Interest coverage from Tata Communications suggests they can manage their debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. When we consider the range of factors above, it seems that Tata Communications is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Tata Communications you should know.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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