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.' 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. We note that DFI Inc. (TPE:2397) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is DFI's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 DFI had NT$944.3m of debt, an increase on none, over one year. But it also has NT$1.73b in cash to offset that, meaning it has NT$785.3m net cash.
How Strong Is DFI's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that DFI had liabilities of NT$2.85b due within 12 months and liabilities of NT$256.3m due beyond that. Offsetting this, it had NT$1.73b in cash and NT$2.09b in receivables that were due within 12 months. So it can boast NT$708.6m more liquid assets than total liabilities.
This short term liquidity is a sign that DFI could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that DFI has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact DFI's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since DFI will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. DFI may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, DFI actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that DFI has net cash of NT$785.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$531m, being 102% of its EBIT. So we don't have any problem with DFI's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for DFI that you should be aware of.
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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