Here's Why DC Infotech and Communication (NSE:DCI) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, DC Infotech and Communication Limited (NSE:DCI) does carry 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for DC Infotech and Communication

How Much Debt Does DC Infotech and Communication Carry?

As you can see below, at the end of September 2020, DC Infotech and Communication had ₹211.0m of debt, up from ₹191.3m a year ago. Click the image for more detail. However, it also had ₹11.1m in cash, and so its net debt is ₹199.9m.

How Healthy Is DC Infotech and Communication's Balance Sheet?

The latest balance sheet data shows that DC Infotech and Communication had liabilities of ₹591.5m due within a year, and liabilities of ₹64.0m falling due after that. Offsetting these obligations, it had cash of ₹11.1m as well as receivables valued at ₹306.8m due within 12 months. So it has liabilities totalling ₹337.6m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹277.5m, we think shareholders really should watch DC Infotech and Communication's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

DC Infotech and Communication has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 3.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, DC Infotech and Communication boosted its EBIT by a silky 82% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since DC Infotech and Communication 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, DC Infotech and Communication saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over DC Infotech and Communication's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that DC Infotech and Communication's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for DC Infotech and Communication you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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