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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Donaco International Limited (ASX:DNA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Donaco International

What Is Donaco International's Net Debt?

The chart below, which you can click on for greater detail, shows that Donaco International had AU$17.8m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds AU$25.1m in cash, so it actually has AU$7.36m net cash.

A Look At Donaco International's Liabilities

According to the last reported balance sheet, Donaco International had liabilities of AU$51.1m due within 12 months, and liabilities of AU$8.95m due beyond 12 months. Offsetting this, it had AU$25.1m in cash and AU$90.3k in receivables that were due within 12 months. So its liabilities total AU$34.9m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of AU$49.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Donaco International boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Donaco International made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$10m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Donaco International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Donaco International actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Donaco International does have more liabilities than liquid assets, it also has net cash of AU$7.36m. The cherry on top was that in converted 170% of that EBIT to free cash flow, bringing in AU$17m. So we are not troubled with Donaco International's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Donaco International has 2 warning signs (and 1 which is concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.