DigiTouch (BIT:DGT) appears to be using debt sparingly

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, DigiTouch SpA (BIT:DGT) is in debt. But should shareholders worry about its use of debt?

When is debt a problem?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for DigiTouch

What is DigiTouch’s debt?

As you can see below, DigiTouch had 11.3 million euros in debt, as of December 2021, which is about the same as the previous year. You can click on the graph for more details. However, he has €7.94m in cash which makes up for this, resulting in a net debt of around €3.39m.

BIT: DGT Debt to Equity History May 6, 2022

How healthy is DigiTouch’s balance sheet?

Zooming in on the latest balance sheet data, we can see that DigiTouch had liabilities of €19.1 million due within 12 months and liabilities of €8.62 million due beyond. On the other hand, it had €7.94 million in cash and €16.3 million in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €3.48 million.

Of course, DigiTouch has a market capitalization of 26.8 million, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

While DigiTouch’s low debt-to-EBITDA ratio of 0.66 suggests only modest debt usage, the fact that EBIT only covered interest expense by 5.3 times last year makes us reflect. We therefore recommend that you closely monitor the impact of financing costs on the business. Above all, DigiTouch has increased its EBIT by 32% over the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine DigiTouch’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, DigiTouch has recorded free cash flow of 92% of its EBIT, which is higher than we would normally expect. This puts him in a very strong position to pay off the debt.

Our point of view

Fortunately, DigiTouch’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, DigiTouch seems to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 1 warning sign for DigiTouch which you should be aware of before investing here.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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