Is Genpact (NYSE: G) a risky investment?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. 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 Genpact Limited (NYSE: G) uses debt. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt 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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is Genpact’s net debt?
The image below, which you can click for more details, shows that in March 2021, Genpact was in debt of $ 1.68 billion, up from $ 1.53 billion in a year. On the flip side, it has $ 651.4 million in cash, resulting in net debt of around $ 1.03 billion.
How strong is Genpact’s balance sheet?
We can see from the most recent balance sheet that Genpact had liabilities of US $ 843.7 million due within one year and liabilities of US $ 2.19 billion due beyond. On the other hand, he had $ 651.4 million in cash and $ 896.6 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 1.49 billion.
Of course, Genpact has a market cap of US $ 8.42 billion, so this liability is likely manageable. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Genpact’s net debt of 1.6 times EBITDA suggests a graceful use of debt. And the attractive interest coverage (EBIT of 10.0 times the interest costs) certainly does do not do everything to dispel this impression. Another good thing is that Genpact has increased its EBIT by 16% over the past year, further increasing its ability to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Genpact’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Genpact has recorded free cash flow totaling 86% of its EBIT, which is higher than what we normally expect. This positions it well to repay debt if it is desirable.
Our point of view
Fortunately, Genpact’s impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. And the good news doesn’t end there, as her coverage of interest also supports that impression! Looking at the big picture, we think Genpact’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. 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. Example: we have spotted 1 warning sign for Genpact you must be aware.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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