Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) makes use of 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Danieli & C. Officine Meccaniche's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Danieli & C. Officine Meccaniche had €526.4m of debt, an increase on €475.6m, over one year. However, it does have €1.65b in cash offsetting this, leading to net cash of €1.12b.
How Strong Is Danieli & C. Officine Meccaniche's Balance Sheet?
According to the last reported balance sheet, Danieli & C. Officine Meccaniche had liabilities of €2.79b due within 12 months, and liabilities of €379.2m due beyond 12 months. Offsetting these obligations, it had cash of €1.65b as well as receivables valued at €1.23b due within 12 months. So it has liabilities totalling €294.0m more than its cash and near-term receivables, combined.
Danieli & C. Officine Meccaniche has a market capitalization of €922.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Danieli & C. Officine Meccaniche also has more cash than debt, so we're pretty confident it can manage its debt safely.
While Danieli & C. Officine Meccaniche doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Danieli & C. Officine Meccaniche'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 company can only pay off debt with cold hard cash, not accounting profits. While Danieli & C. Officine Meccaniche 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. In the last three years, Danieli & C. Officine Meccaniche created free cash flow amounting to 12% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Although Danieli & C. Officine Meccaniche's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €1.12b. So we are not troubled with Danieli & C. Officine Meccaniche's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Danieli & C. Officine Meccaniche, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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