DCC (LON:DCC) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that DCC plc (LON:DCC) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See 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£1.99b at the end of March 2024, a reduction from UK£2.34b over a year. However, because it has a cash reserve of UK£1.11b, its net debt is less, at about UK£882.5m.

A Look At DCC's Liabilities

According to the last reported balance sheet, DCC had liabilities of UK£3.74b due within 12 months, and liabilities of UK£2.56b due beyond 12 months. Offsetting this, it had UK£1.11b in cash and UK£2.17b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£3.02b.

This deficit isn't so bad because DCC is worth UK£5.60b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.1 and interest cover of 5.4 times, it seems to us that DCC is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We saw DCC grow its EBIT by 6.8% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if DCC can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, DCC recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis DCC's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think DCC is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check DCC's dividend history, without delay!

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.