Dixons Carphone (LON:DC.) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Dixons Carphone plc (LON:DC.) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Dixons Carphone

What Is Dixons Carphone's Net Debt?

The image below, which you can click on for greater detail, shows that Dixons Carphone had debt of UK£71.0m at the end of October 2020, a reduction from UK£343.0m over a year. But it also has UK£340.0m in cash to offset that, meaning it has UK£269.0m net cash.

How Healthy Is Dixons Carphone's Balance Sheet?

The latest balance sheet data shows that Dixons Carphone had liabilities of UK£3.20b due within a year, and liabilities of UK£2.12b falling due after that. Offsetting this, it had UK£340.0m in cash and UK£782.0m in receivables that were due within 12 months. So its liabilities total UK£4.19b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£1.66b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Dixons Carphone would probably need a major re-capitalization if its creditors were to demand repayment. Dixons Carphone boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

We note that Dixons Carphone grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 Dixons Carphone's ability to maintain a healthy balance sheet going forward. 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. While Dixons Carphone 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, Dixons Carphone actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Dixons Carphone does have more liabilities than liquid assets, it also has net cash of UK£269.0m. The cherry on top was that in converted 144% of that EBIT to free cash flow, bringing in UK£842m. So we don't have any problem with Dixons Carphone's use of debt. Even though Dixons Carphone lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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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