Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 DMC Global Inc. (NASDAQ:BOOM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is DMC Global's Debt?
You can click the graphic below for the historical numbers, but it shows that DMC Global had US$4.79m of debt in December 2019, down from US$41.4m, one year before. However, it does have US$20.4m in cash offsetting this, leading to net cash of US$15.6m.
How Healthy Is DMC Global's Balance Sheet?
According to the last reported balance sheet, DMC Global had liabilities of US$71.4m due within 12 months, and liabilities of US$33.9m due beyond 12 months. Offsetting these obligations, it had cash of US$20.4m as well as receivables valued at US$60.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$24.1m.
Given DMC Global has a market capitalization of US$577.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, DMC Global also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, DMC Global grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. 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 DMC Global's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. DMC Global may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, DMC Global created free cash flow amounting to 15% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
We could understand if investors are concerned about DMC Global's liabilities, but we can be reassured by the fact it has has net cash of US$15.6m. And it impressed us with its EBIT growth of 56% over the last year. So is DMC Global'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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with DMC Global .
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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