Is Danieli & C. Officine Meccaniche (BIT:DAN) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Danieli & C. Officine Meccaniche

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

The image below, which you can click on for greater detail, shows that at December 2021 Danieli & C. Officine Meccaniche had debt of €652.9m, up from €543.3m in one year. However, its balance sheet shows it holds €1.78b in cash, so it actually has €1.13b net cash.

A Look At Danieli & C. Officine Meccaniche's Liabilities

We can see from the most recent balance sheet that Danieli & C. Officine Meccaniche had liabilities of €3.23b falling due within a year, and liabilities of €381.5m due beyond that. Offsetting this, it had €1.78b in cash and €1.05b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €772.6m.

This deficit is considerable relative to its market capitalization of €1.19b, so it does suggest shareholders should keep an eye on Danieli & C. Officine Meccaniche's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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!

Fortunately, Danieli & C. Officine Meccaniche grew its EBIT by 8.9% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Danieli & C. Officine Meccaniche has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Danieli & C. Officine Meccaniche recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Danieli & C. Officine Meccaniche does have more liabilities than liquid assets, it also has net cash of €1.13b. And it also grew its EBIT by 8.9% over the last year. So we don't have any problem with Danieli & C. Officine Meccaniche's use of debt. 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. Be aware that Danieli & C. Officine Meccaniche is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.