Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Digital Value S.p.A. (BIT:DGV) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Digital Value's Debt?
As you can see below, at the end of June 2020, Digital Value had €15.6m of debt, up from €11.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds €30.8m in cash, so it actually has €15.3m net cash.
How Healthy Is Digital Value's Balance Sheet?
According to the last reported balance sheet, Digital Value had liabilities of €207.7m due within 12 months, and liabilities of €19.0m due beyond 12 months. On the other hand, it had cash of €30.8m and €102.8m worth of receivables due within a year. So it has liabilities totalling €93.2m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Digital Value is worth €378.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Digital Value also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Digital Value grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. 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 Digital Value'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Digital Value 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. In the last two years, Digital Value created free cash flow amounting to 6.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Although Digital Value's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €15.3m. And we liked the look of last year's 33% year-on-year EBIT growth. So we don't have any problem with Digital Value'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. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Digital Value (of which 1 doesn't sit too well with us!) you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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