Here's Why Donaco International (ASX:DNA) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Donaco International Limited (ASX:DNA) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Donaco International

What Is Donaco International's Debt?

The image below, which you can click on for greater detail, shows that Donaco International had debt of AU$28.2m at the end of June 2020, a reduction from AU$35.9m over a year. However, it also had AU$13.0m in cash, and so its net debt is AU$15.2m.

How Healthy Is Donaco International's Balance Sheet?

We can see from the most recent balance sheet that Donaco International had liabilities of AU$69.8m falling due within a year, and liabilities of AU$3.71m due beyond that. Offsetting these obligations, it had cash of AU$13.0m as well as receivables valued at AU$1.28m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$59.2m.

This is a mountain of leverage relative to its market capitalization of AU$74.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Donaco International will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Donaco International made a loss at the EBIT level, and saw its revenue drop to AU$53m, which is a fall of 38%. To be frank that doesn't bode well.

Caveat Emptor

While Donaco International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at AU$2.1m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$4.3m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Donaco International (at least 1 which is significant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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