Is Darco Water Technologies (SGX:BLR) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Darco Water Technologies Limited (SGX:BLR) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Darco Water Technologies

What Is Darco Water Technologies's Debt?

The image below, which you can click on for greater detail, shows that Darco Water Technologies had debt of S$4.90m at the end of December 2021, a reduction from S$6.40m over a year. But it also has S$23.4m in cash to offset that, meaning it has S$18.5m net cash.

How Strong Is Darco Water Technologies' Balance Sheet?

We can see from the most recent balance sheet that Darco Water Technologies had liabilities of S$45.4m falling due within a year, and liabilities of S$1.11m due beyond that. Offsetting this, it had S$23.4m in cash and S$40.7m in receivables that were due within 12 months. So it actually has S$17.6m more liquid assets than total liabilities.

This luscious liquidity implies that Darco Water Technologies' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Darco Water Technologies has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Darco Water Technologies 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.

In the last year Darco Water Technologies had a loss before interest and tax, and actually shrunk its revenue by 30%, to S$55m. That makes us nervous, to say the least.

So How Risky Is Darco Water Technologies?

While Darco Water Technologies lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow S$4.4m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. There's no doubt the next few years will be crucial to how the business matures. 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, we've discovered 3 warning signs for Darco Water Technologies (2 are potentially serious!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.