These 4 Measures Indicate That Dutch Lady Milk Industries Berhad (KLSE:DLADY) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Dutch Lady Milk Industries Berhad (KLSE:DLADY) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dutch Lady Milk Industries Berhad

What Is Dutch Lady Milk Industries Berhad's Net Debt?

As you can see below, Dutch Lady Milk Industries Berhad had RM16.7m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has RM56.6m in cash, leading to a RM39.9m net cash position.

How Strong Is Dutch Lady Milk Industries Berhad's Balance Sheet?

According to the last reported balance sheet, Dutch Lady Milk Industries Berhad had liabilities of RM324.2m due within 12 months, and liabilities of RM8.08m due beyond 12 months. Offsetting these obligations, it had cash of RM56.6m as well as receivables valued at RM80.5m due within 12 months. So it has liabilities totalling RM195.2m more than its cash and near-term receivables, combined.

Given Dutch Lady Milk Industries Berhad has a market capitalization of RM2.19b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Dutch Lady Milk Industries Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Dutch Lady Milk Industries Berhad's saving grace is its low debt levels, because its EBIT has tanked 28% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Dutch Lady Milk Industries Berhad'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Dutch Lady Milk Industries Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Dutch Lady Milk Industries Berhad produced sturdy free cash flow equating to 57% 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 Dutch Lady Milk Industries Berhad has RM39.9m in net cash. So we don't have any problem with Dutch Lady Milk Industries Berhad's use of debt. 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. For example - Dutch Lady Milk Industries Berhad has 2 warning signs we think you should be aware of.

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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