Here's Why DigiTouch (BIT:DGT) Has A Meaningful Debt Burden

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.' 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. As with many other companies DigiTouch S.p.A. (BIT:DGT) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for DigiTouch

What Is DigiTouch's Net Debt?

The chart below, which you can click on for greater detail, shows that DigiTouch had €11.4m in debt in December 2020; about the same as the year before. On the flip side, it has €9.12m in cash leading to net debt of about €2.28m.

A Look At DigiTouch's Liabilities

Zooming in on the latest balance sheet data, we can see that DigiTouch had liabilities of €15.7m due within 12 months and liabilities of €9.55m due beyond that. On the other hand, it had cash of €9.12m and €14.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.25m.

Of course, DigiTouch has a market capitalization of €18.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.59 and interest cover of 4.1 times, it seems to us that DigiTouch is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. The bad news is that DigiTouch saw its EBIT decline by 20% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 DigiTouch'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, DigiTouch recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

DigiTouch's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its net debt to EBITDA was refreshing. When we consider all the factors discussed, it seems to us that DigiTouch is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 2 warning signs with DigiTouch (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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