DKSH Holding (VTX:DKSH) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies DKSH Holding AG (VTX:DKSH) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for DKSH Holding

What Is DKSH Holding's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 DKSH Holding had CHF338.6m of debt, an increase on CHF279.7m, over one year. But it also has CHF680.8m in cash to offset that, meaning it has CHF342.2m net cash.

How Healthy Is DKSH Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DKSH Holding had liabilities of CHF2.89b due within 12 months and liabilities of CHF431.0m due beyond that. Offsetting these obligations, it had cash of CHF680.8m as well as receivables valued at CHF2.35b due within 12 months. So it has liabilities totalling CHF286.7m more than its cash and near-term receivables, combined.

Of course, DKSH Holding has a market capitalization of CHF4.72b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, DKSH Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, DKSH Holding saw its EBIT drop by 8.4% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if DKSH Holding can strengthen its balance sheet over time. 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 DKSH Holding 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. Over the last three years, DKSH Holding recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about DKSH Holding's liabilities, but we can be reassured by the fact it has has net cash of CHF342.2m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in CHF290m. So we don't think DKSH Holding's use of debt is risky. 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. Be aware that DKSH Holding is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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