Digi.Com Berhad (KLSE:DIGI) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Digi.Com Berhad (KLSE:DIGI) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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.

Check out our latest analysis for Digi.Com Berhad

How Much Debt Does Digi.Com Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that Digi.Com Berhad had RM2.29b of debt in June 2022, down from RM2.69b, one year before. However, because it has a cash reserve of RM138.0m, its net debt is less, at about RM2.15b.

How Strong Is Digi.Com Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Digi.Com Berhad had liabilities of RM2.80b due within 12 months and liabilities of RM4.27b due beyond that. Offsetting these obligations, it had cash of RM138.0m as well as receivables valued at RM1.17b due within 12 months. So it has liabilities totalling RM5.76b more than its cash and near-term receivables, combined.

Digi.Com Berhad has a market capitalization of RM26.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Digi.Com Berhad has a low net debt to EBITDA ratio of only 0.70. And its EBIT covers its interest expense a whopping 11.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Digi.Com Berhad has seen its EBIT plunge 11% in the last twelve months. 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 future earnings, more than anything, that will determine Digi.Com Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Digi.Com Berhad recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On our analysis Digi.Com Berhad's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. Considering this range of data points, we think Digi.Com Berhad is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Digi.Com Berhad that you should be aware of before investing here.

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.