Digi Communications (BVB: DIGI) Using Debt Could Be Seen Risky
Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Digi Communications SA (BVB: DIGI) uses debt in its business. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest review for Digi Communications
What is Digi Communications’ net debt?
As you can see below, at the end of September 2021, Digi Communications had € 1.14 billion in debt, up from € 1.08 billion a year ago. Click on the image for more details. However, he also had 43.3 million euros in cash, so his net debt is 1.09 billion euros.
How strong is Digi Communications’ balance sheet?
According to the latest published balance sheet, Digi Communications had liabilities of 812.9 million euros maturing in less than 12 months and liabilities of 1.33 billion euros maturing beyond 12 months. On the other hand, it had cash of € 43.3 million and € 165.2 million in receivables within one year. Its liabilities therefore amount to € 1.94 billion more than the combination of its cash and short-term receivables.
The deficit here weighs heavily on the € 767.6million business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . We would therefore monitor its record closely, without a doubt. Ultimately, Digi Communications would likely need a major recapitalization if its creditors demanded repayment.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt versus earnings with and without amortization expenses.
Digi Communications’ debt is 3.1 times its EBITDA and its EBIT covers its interest expense 3.6 times. This suggests that while debt levels are significant, we would stop calling them problematic. Notably, Digi Communications’ EBIT has been fairly stable over the past year, which is not ideal given the leverage. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Digi Communications’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Digi Communications has reported free cash flow of 8.5% of its EBIT, which is really pretty low. For us, the conversion to cash that elicits a bit of paranoia is the ability to extinguish debt.
Our point of view
Reflecting on Digi Communications’ attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But at least its EBIT growth rate isn’t that bad. We’re pretty clear that we consider Digi Communications to be really rather risky, given the health of its balance sheet. For this reason, we are fairly cautious about the stock, and we believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example – Digi Communications has 1 warning sign we think you should be aware.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.