Dynacons Systems & Solutions (NSE:DSSL) 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. As with many other companies Dynacons Systems & Solutions Limited (NSE:DSSL) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Dynacons Systems & Solutions

How Much Debt Does Dynacons Systems & Solutions Carry?

As you can see below, at the end of March 2023, Dynacons Systems & Solutions had ₹686.3m of debt, up from ₹641.5m a year ago. Click the image for more detail. On the flip side, it has ₹458.6m in cash leading to net debt of about ₹227.7m.

How Strong Is Dynacons Systems & Solutions' Balance Sheet?

We can see from the most recent balance sheet that Dynacons Systems & Solutions had liabilities of ₹2.77b falling due within a year, and liabilities of ₹212.8m due beyond that. Offsetting these obligations, it had cash of ₹458.6m as well as receivables valued at ₹3.01b due within 12 months. So it actually has ₹493.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Dynacons Systems & Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.34 and interest cover of 6.3 times, it seems to us that Dynacons Systems & Solutions 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. Better yet, Dynacons Systems & Solutions grew its EBIT by 104% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Dynacons Systems & Solutions will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Dynacons Systems & Solutions reported free cash flow worth 3.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Dynacons Systems & Solutions's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Dynacons Systems & Solutions is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Dynacons Systems & Solutions .

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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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.