These 4 Measures Indicate That Digi Communications (BVB:DIGI) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Digi Communications N.V. (BVB:DIGI) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

View our latest analysis for Digi Communications

What Is Digi Communications’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that Digi Communications had €1.16b of debt in September 2024, down from €1.39b, one year before. However, because it has a cash reserve of €297.1m, its net debt is less, at about €863.8m.

How Healthy Is Digi Communications’ Balance Sheet?

The latest balance sheet data shows that Digi Communications had liabilities of €1.20b due within a year, and liabilities of €1.37b falling due after that. Offsetting these obligations, it had cash of €297.1m as well as receivables valued at €286.6m due within 12 months. So it has liabilities totalling €1.99b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €1.26b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Digi Communications would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Digi Communications has a low net debt to EBITDA ratio of only 0.96. And its EBIT covers its interest expense a whopping 10.1 times over. So we’re pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Digi Communications grew its EBIT by 291% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Digi Communications’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. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Digi Communications saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Digi Communications’s level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Once we consider all the factors above, together, it seems to us that Digi Communications’s debt is making it a bit risky. That’s not necessarily a bad thing, but we’d generally feel more comfortable with less leverage. 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. For example Digi Communications has 3 warning signs (and 2 which don’t sit too well with us) we think you should know about.

If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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.