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.' 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 can see that DCC plc (LON:DCC) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for DCC
What Is DCC's Debt?
The image below, which you can click on for greater detail, shows that DCC had debt of UK£1.78b at the end of March 2021, a reduction from UK£2.12b over a year. However, it does have UK£1.80b in cash offsetting this, leading to net cash of UK£20.1m.
How Healthy Is DCC's Balance Sheet?
According to the last reported balance sheet, DCC had liabilities of UK£3.00b due within 12 months, and liabilities of UK£2.33b due beyond 12 months. On the other hand, it had cash of UK£1.80b and UK£1.55b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.98b.
While this might seem like a lot, it is not so bad since DCC has a market capitalization of UK£6.07b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, DCC also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, DCC grew its EBIT by 7.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine DCC'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. DCC 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 three years, DCC recorded free cash flow worth a fulsome 93% 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
While DCC does have more liabilities than liquid assets, it also has net cash of UK£20.1m. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in UK£565m. So is DCC's debt a risk? It doesn't seem so to us. 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 DCC .
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.
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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.
