Is Donaco International (ASX:DNA) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Donaco International Limited (ASX:DNA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Donaco International

How Much Debt Does Donaco International Carry?

As you can see below, at the end of December 2022, Donaco International had AU$18.2m of debt, up from AU$11.7m a year ago. Click the image for more detail. However, because it has a cash reserve of AU$9.33m, its net debt is less, at about AU$8.92m.

How Strong Is Donaco International's Balance Sheet?

According to the last reported balance sheet, Donaco International had liabilities of AU$48.0m due within 12 months, and liabilities of AU$8.83m due beyond 12 months. On the other hand, it had cash of AU$9.33m and AU$205.8k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$47.3m.

This deficit is considerable relative to its market capitalization of AU$54.3m, so it does suggest shareholders should keep an eye on Donaco International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Donaco International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Donaco International wasn't profitable at an EBIT level, but managed to grow its revenue by 119%, to AU$11m. So there's no doubt that shareholders are cheering for growth

Caveat Emptor

Despite the top line growth, Donaco International still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$6.6m at the EBIT level. 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$614k of cash over the last year. So to be blunt we think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Donaco International .

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.