Here's Why Danieli & C. Officine Meccaniche (BIT:DAN) Can Manage Its Debt Responsibly

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.' 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 note that Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Danieli & C. Officine Meccaniche

How Much Debt Does Danieli & C. Officine Meccaniche Carry?

As you can see below, Danieli & C. Officine Meccaniche had €543.3m of debt at December 2020, down from €646.0m a year prior. But it also has €1.69b in cash to offset that, meaning it has €1.15b net cash.

How Strong Is Danieli & C. Officine Meccaniche's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Danieli & C. Officine Meccaniche had liabilities of €2.76b due within 12 months and liabilities of €429.9m due beyond that. On the other hand, it had cash of €1.69b and €974.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €524.0m.

While this might seem like a lot, it is not so bad since Danieli & C. Officine Meccaniche has a market capitalization of €1.62b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Danieli & C. Officine Meccaniche boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Danieli & C. Officine Meccaniche grew its EBIT at 11% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Danieli & C. Officine Meccaniche'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. Danieli & C. Officine Meccaniche 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. Looking at the most recent three years, Danieli & C. Officine Meccaniche recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Danieli & C. Officine Meccaniche's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €1.15b. And it also grew its EBIT by 11% over the last year. So we are not troubled with Danieli & C. Officine Meccaniche's debt use. 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. For example - Danieli & C. Officine Meccaniche has 2 warning signs we think you should be aware of.

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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