Is DFCITY Group Berhad (KLSE:DFCITY) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, DFCITY Group Berhad (KLSE:DFCITY) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for DFCITY Group Berhad

How Much Debt Does DFCITY Group Berhad Carry?

As you can see below, DFCITY Group Berhad had RM26.3m of debt at September 2022, down from RM31.4m a year prior. However, it also had RM8.18m in cash, and so its net debt is RM18.1m.

How Healthy Is DFCITY Group Berhad's Balance Sheet?

The latest balance sheet data shows that DFCITY Group Berhad had liabilities of RM22.1m due within a year, and liabilities of RM14.6m falling due after that. On the other hand, it had cash of RM8.18m and RM6.34m worth of receivables due within a year. So its liabilities total RM22.2m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since DFCITY Group Berhad has a market capitalization of RM46.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.77 times and a disturbingly high net debt to EBITDA ratio of 9.2 hit our confidence in DFCITY Group Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for DFCITY Group Berhad is that it turned last year's EBIT loss into a gain of RM1.0m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is DFCITY Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, DFCITY Group Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

DFCITY Group Berhad's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that DFCITY Group Berhad's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with DFCITY Group Berhad (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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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.