Warren Buffett famously said, '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 Dufu Technology Corp. Berhad (KLSE:DUFU) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Dufu Technology Berhad's Net Debt?
The chart below, which you can click on for greater detail, shows that Dufu Technology Berhad had RM17.0m in debt in December 2021; about the same as the year before. But it also has RM85.0m in cash to offset that, meaning it has RM68.0m net cash.
A Look At Dufu Technology Berhad's Liabilities
According to the last reported balance sheet, Dufu Technology Berhad had liabilities of RM63.9m due within 12 months, and liabilities of RM10.1m due beyond 12 months. Offsetting this, it had RM85.0m in cash and RM99.2m in receivables that were due within 12 months. So it actually has RM110.2m more liquid assets than total liabilities.
This surplus suggests that Dufu Technology Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Dufu Technology Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Dufu Technology Berhad grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Dufu Technology Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dufu Technology 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. In the last three years, Dufu Technology Berhad created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Dufu Technology Berhad has net cash of RM68.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 18% over the last year. So we don't think Dufu Technology Berhad's use of debt is risky. 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. We've identified 3 warning signs with Dufu Technology Berhad (at least 1 which is significant) , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.