Stock Analysis

These 4 Measures Indicate That Dynacons Systems & Solutions (NSE:DSSL) Is Using Debt Reasonably Well

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Dynacons Systems & Solutions Limited (NSE:DSSL) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Dynacons Systems & Solutions's Net Debt?

As you can see below, at the end of September 2022, Dynacons Systems & Solutions had ₹681.4m of debt, up from ₹639.8m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹418.9m, its net debt is less, at about ₹262.4m.

NSEI:DSSL Debt to Equity History March 15th 2023

How Strong Is Dynacons Systems & Solutions' Balance Sheet?

We can see from the most recent balance sheet that Dynacons Systems & Solutions had liabilities of ₹2.62b falling due within a year, and liabilities of ₹215.9m due beyond that. Offsetting these obligations, it had cash of ₹418.9m as well as receivables valued at ₹2.58b due within 12 months. So it can boast ₹169.2m more liquid assets than total liabilities.

This surplus suggests that Dynacons Systems & Solutions has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

While Dynacons Systems & Solutions's low debt to EBITDA ratio of 0.56 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.3 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. On top of that, Dynacons Systems & Solutions grew its EBIT by 100% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Dynacons Systems & Solutions's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Dynacons Systems & Solutions recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Happily, Dynacons Systems & Solutions's impressive EBIT growth rate implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Dynacons Systems & Solutions can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Dynacons Systems & Solutions 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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