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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that DCC plc (LON:DCC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for DCC
What Is DCC's Debt?
As you can see below, DCC had UK£1.78b of debt at March 2021, down from UK£2.12b a year prior. However, it does have UK£1.79b in cash offsetting this, leading to net cash of UK£3.20m.
A Look At DCC's Liabilities
Zooming in on the latest balance sheet data, we can see that DCC had liabilities of UK£3.00b due within 12 months and liabilities of UK£2.33b due beyond that. Offsetting these obligations, it had cash of UK£1.79b as well as receivables valued at UK£1.69b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.85b.
This deficit isn't so bad because DCC is worth UK£6.02b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, DCC boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that DCC has increased its EBIT by 8.6% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if DCC 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 company can only pay off debt with cold hard cash, not accounting profits. While DCC 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, DCC generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
Although DCC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£3.20m. And it impressed us with free cash flow of UK£565m, being 93% of its EBIT. So we are not troubled with DCC'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. To that end, you should be aware of the 1 warning sign we've spotted with DCC .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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About LSE:DCC
DCC
Engages in the sales, marketing, and distribution of carbon energy solutions worldwide.
Very undervalued with flawless balance sheet and pays a dividend.
