Data#3 (ASX:DTL) Seems To Use Debt Rather Sparingly

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Data#3 Limited (ASX:DTL) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to sure up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Data#3

What Is Data#3's Debt?

As you can see below, Data#3 had AU$118.0k of debt at December 2018, down from AU$554.0k a year prior. But on the other hand it also has AU$7.30m in cash, leading to a AU$7.18m net cash position.

How Strong Is Data#3's Balance Sheet?

We can see from the most recent balance sheet that Data#3 had liabilities of AU$140.7m falling due within a year, and liabilities of AU$3.68m due beyond that. Offsetting these obligations, it had cash of AU$7.30m as well as receivables valued at AU$141.3m due within 12 months. So it actually has AU$4.16m more liquid assets than total liabilities.

This state of affairs indicates that Data#3's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$326.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. Data#3 boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Data#3 grew its EBIT by 38% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Data#3's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Data#3 has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Data#3 produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Data#3 has net cash of AU$7.2m, as well as more liquid assets than liabilities. And we liked the look of last year's 38% year-on-year EBIT growth. So is Data#3's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Data#3 would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.