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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.' 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. Importantly, Digi International Inc. (NASDAQ:DGII) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Digi International Carry?
The image below, which you can click on for greater detail, shows that Digi International had debt of US$45.5m at the end of March 2021, a reduction from US$106.9m over a year. However, it does have US$127.2m in cash offsetting this, leading to net cash of US$81.6m.
How Strong Is Digi International's Balance Sheet?
According to the last reported balance sheet, Digi International had liabilities of US$56.9m due within 12 months, and liabilities of US$91.5m due beyond 12 months. Offsetting this, it had US$127.2m in cash and US$44.1m in receivables that were due within 12 months. So it can boast US$22.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Digi International could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Digi International boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Digi International has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Digi International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Digi International 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, Digi International actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case Digi International has US$81.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$67m, being 198% of its EBIT. So is Digi International's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Digi International you should know about.
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.
This article by Simply Wall St is general in nature. 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.
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