Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 The Descartes Systems Group Inc (TSE:DSG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Descartes Systems Group's Debt?
The image below, which you can click on for greater detail, shows that Descartes Systems Group had debt of US$22.8m at the end of July 2019, a reduction from US$58.8m over a year. However, it does have US$27.4m in cash offsetting this, leading to net cash of US$4.61m.
A Look At Descartes Systems Group's Liabilities
We can see from the most recent balance sheet that Descartes Systems Group had liabilities of US$87.6m falling due within a year, and liabilities of US$56.1m due beyond that. Offsetting this, it had US$27.4m in cash and US$37.8m in receivables that were due within 12 months. So its liabilities total US$78.5m more than the combination of its cash and short-term receivables.
Of course, Descartes Systems Group has a market capitalization of US$3.61b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Descartes Systems Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Descartes Systems Group grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Descartes Systems Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Descartes Systems Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Descartes Systems Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Descartes Systems Group's liabilities, but we can be reassured by the fact it has has net cash of US$4.61m. The cherry on top was that in converted 173% of that EBIT to free cash flow, bringing in US$86m. So is Descartes Systems Group's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Descartes Systems Group, you may well want to click here to check an interactive graph of its earnings per share history.
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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