Is Directa Plus (LON:DCTA) Using Too Much Debt?

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.' 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 can see that Directa Plus Plc (LON:DCTA) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Directa Plus

How Much Debt Does Directa Plus Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Directa Plus had debt of €2.00m, up from €484.7k in one year. However, its balance sheet shows it holds €7.08m in cash, so it actually has €5.08m net cash.

A Look At Directa Plus' Liabilities

The latest balance sheet data shows that Directa Plus had liabilities of €4.88m due within a year, and liabilities of €2.16m falling due after that. Offsetting this, it had €7.08m in cash and €2.86m in receivables that were due within 12 months. So it can boast €2.89m more liquid assets than total liabilities.

This short term liquidity is a sign that Directa Plus could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Directa Plus has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Directa Plus'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.

In the last year Directa Plus wasn't profitable at an EBIT level, but managed to grow its revenue by 157%, to €6.8m. So its pretty obvious shareholders are hoping for more growth!

So How Risky Is Directa Plus?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Directa Plus lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of €4.7m and booked a €4.2m accounting loss. But the saving grace is the €5.08m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. The good news for shareholders is that Directa Plus has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Directa Plus is showing 3 warning signs in our investment analysis , you should know about...

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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