De'Longhi (BIT:DLG) Seems To Use Debt Quite Sensibly

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. We can see that De'Longhi S.p.A. (BIT:DLG) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for De'Longhi

What Is De'Longhi's Net Debt?

The image below, which you can click on for greater detail, shows that De'Longhi had debt of €811.1m at the end of June 2023, a reduction from €929.4m over a year. But it also has €842.7m in cash to offset that, meaning it has €31.6m net cash.

A Look At De'Longhi's Liabilities

The latest balance sheet data shows that De'Longhi had liabilities of €930.4m due within a year, and liabilities of €900.1m falling due after that. On the other hand, it had cash of €842.7m and €425.3m worth of receivables due within a year. So it has liabilities totalling €562.5m more than its cash and near-term receivables, combined.

Of course, De'Longhi has a market capitalization of €3.53b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, De'Longhi boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that De'Longhi saw its EBIT decline by 9.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if De'Longhi can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While De'Longhi 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. During the last three years, De'Longhi generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although De'Longhi's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €31.6m. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in €386m. So we don't have any problem with De'Longhi's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for De'Longhi that 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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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.