Is Digital Bros (BIT:DIB) A Risky Investment?

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.' 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, Digital Bros S.p.A. (BIT:DIB) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Digital Bros

What Is Digital Bros's Net Debt?

The image below, which you can click on for greater detail, shows that Digital Bros had debt of €11.5m at the end of December 2020, a reduction from €12.9m over a year. But on the other hand it also has €12.9m in cash, leading to a €1.35m net cash position.

A Look At Digital Bros' Liabilities

Zooming in on the latest balance sheet data, we can see that Digital Bros had liabilities of €67.6m due within 12 months and liabilities of €5.75m due beyond that. Offsetting this, it had €12.9m in cash and €51.2m in receivables that were due within 12 months. So its liabilities total €9.31m more than the combination of its cash and short-term receivables.

Since publicly traded Digital Bros shares are worth a total of €336.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Digital Bros boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Digital Bros grew its EBIT by 294% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Digital Bros 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. Digital Bros 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. During the last two years, Digital Bros produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Digital Bros has €1.35m in net cash. And we liked the look of last year's 294% year-on-year EBIT growth. So is Digital Bros's debt a risk? It doesn't seem so to us. 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, we've discovered 1 warning sign for Digital Bros that you should be aware of before investing here.

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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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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