Dom Development (WSE: DOM) could easily take on more debt
Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Dom DÃ©veloppement SA (WSE: DOM) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Dom Development
How much debt does Dom Development carry?
As you can see below, Dom Development had a debt of Z370.0million in March 2021, up from Z693.4million a year earlier. However, his balance sheet shows that he holds Z601.5million in cash, so he actually has net cash of Z231.5million.
How strong is Dom Development’s balance sheet?
We can see from the most recent balance sheet that Dom Development had a liability of Z 1.35 billion maturing within one year and a liability of Z 457.8 million beyond that. In compensation for these obligations, he had cash of Z 601.5 million as well as receivables valued at Z 140.9 million due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 1.06 z.
This deficit is not that big as Dom Development is worth Z 3.94 billion, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky. While he has some liabilities to note, Dom Development also has more cash than debt, so we’re pretty confident that he can handle his debt safely.
Best of all, Dom Development increased its EBIT by 110% last year, which is an impressive improvement. This boost will make it even easier to pay down debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But in the end, the company’s future profitability will decide whether Dom Development can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debt with hard cash, not with book profits. While Dom Development has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. Over the past three years, Dom Development has generated free cash flow of 87% of its very robust EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Although Dom Development has more liabilities than liquid assets, it also has a net cash position of Z 231.5million. And he impressed us with free cash flow of Z630million, or 87% of his EBIT. Is Dom Development’s debt therefore a risk? It does not seem to us. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Dom Development (1 of which is potentially serious!) that you should be aware of.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth net stocks today.
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