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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.' 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. We note that Donaco International Limited (ASX:DNA) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
What Is Donaco International's Net Debt?
The image below, which you can click on for greater detail, shows that Donaco International had debt of AU$11.8m at the end of December 2020, a reduction from AU$27.8m over a year. But on the other hand it also has AU$12.7m in cash, leading to a AU$857.3k net cash position.
A Look At Donaco International's Liabilities
Zooming in on the latest balance sheet data, we can see that Donaco International had liabilities of AU$32.4m due within 12 months and liabilities of AU$7.52m due beyond that. Offsetting these obligations, it had cash of AU$12.7m as well as receivables valued at AU$1.83m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$25.4m.
While this might seem like a lot, it is not so bad since Donaco International has a market capitalization of AU$63.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Donaco International also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Donaco International 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.
Over 12 months, Donaco International made a loss at the EBIT level, and saw its revenue drop to AU$19m, which is a fall of 78%. That makes us nervous, to say the least.
So How Risky Is Donaco International?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Donaco International had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$9.7m and booked a AU$15m accounting loss. With only AU$857.3k on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. We've identified 5 warning signs with Donaco International (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.
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.
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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