These 4 Measures Indicate That Dancomech Holdings Berhad (KLSE:DANCO) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Dancomech Holdings Berhad (KLSE:DANCO) does carry debt. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dancomech Holdings Berhad

How Much Debt Does Dancomech Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Dancomech Holdings Berhad had debt of RM9.91m, up from RM1.33m in one year. But on the other hand it also has RM50.8m in cash, leading to a RM40.8m net cash position.

A Look At Dancomech Holdings Berhad's Liabilities

We can see from the most recent balance sheet that Dancomech Holdings Berhad had liabilities of RM26.4m falling due within a year, and liabilities of RM11.6m due beyond that. On the other hand, it had cash of RM50.8m and RM35.1m worth of receivables due within a year. So it actually has RM48.0m more liquid assets than total liabilities.

This excess liquidity suggests that Dancomech Holdings Berhad is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Dancomech Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Dancomech Holdings Berhad's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dancomech Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dancomech Holdings Berhad 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. Over the most recent three years, Dancomech Holdings Berhad recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Dancomech Holdings Berhad has RM40.8m in net cash and a decent-looking balance sheet. So is Dancomech Holdings Berhad's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Dancomech Holdings Berhad , 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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