Digital China Holdings (HKG:861) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Digital China Holdings Limited (HKG:861) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Digital China Holdings

How Much Debt Does Digital China Holdings Carry?

The image below, which you can click on for greater detail, shows that Digital China Holdings had debt of HK$3.97b at the end of December 2021, a reduction from HK$4.38b over a year. However, it does have HK$4.55b in cash offsetting this, leading to net cash of HK$572.1m.

How Healthy Is Digital China Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Digital China Holdings had liabilities of HK$10.9b due within 12 months and liabilities of HK$3.83b due beyond that. Offsetting these obligations, it had cash of HK$4.55b as well as receivables valued at HK$7.87b due within 12 months. So it has liabilities totalling HK$2.32b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Digital China Holdings is worth HK$6.31b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Digital China Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Digital China Holdings grew its EBIT by 131% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Digital China Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Digital China Holdings 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, Digital China Holdings 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 Digital China Holdings does have more liabilities than liquid assets, it also has net cash of HK$572.1m. And it impressed us with free cash flow of HK$394m, being 118% of its EBIT. So is Digital China Holdings'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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Digital China Holdings you should know about.

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.