Does D'nonce Technology Bhd (KLSE:DNONCE) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that D'nonce Technology Bhd. (KLSE:DNONCE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for D'nonce Technology Bhd

How Much Debt Does D'nonce Technology Bhd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 D'nonce Technology Bhd had RM56.3m of debt, an increase on RM53.7m, over one year. However, because it has a cash reserve of RM56.0m, its net debt is less, at about RM335.0k.

How Healthy Is D'nonce Technology Bhd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that D'nonce Technology Bhd had liabilities of RM55.5m due within 12 months and liabilities of RM46.8m due beyond that. Offsetting this, it had RM56.0m in cash and RM61.6m in receivables that were due within 12 months. So it can boast RM15.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that D'nonce Technology Bhd's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Carrying virtually no net debt, D'nonce Technology Bhd has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

D'nonce Technology Bhd has a net debt to EBITDA ratio of 0.04, suggesting a very conservative balance sheet. But strangely, EBIT was only 0.046 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Notably, D'nonce Technology Bhd's EBIT launched higher than Elon Musk, gaining a whopping 1,106% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since D'nonce Technology Bhd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, D'nonce Technology Bhd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

The good news is that D'nonce Technology Bhd's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Taking all this data into account, it seems to us that D'nonce Technology Bhd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 instance, we've identified 4 warning signs for D'nonce Technology Bhd (3 are a bit concerning) you should be aware of.

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.