David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ 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. Like many other companies DLH Holdings Corp. (NASDAQ: DLHC) uses debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. 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.
How much debt does DLH Holdings have?
As you can see below, at the end of June 2021, DLH Holdings had $ 51.5 million in debt, up from $ 42.5 million a year ago. Click on the image for more details. And he doesn’t have a lot of cash, so his net debt is about the same.
NasdaqCM: DLHC Equity Debt History October 9, 2021
How healthy is DLH Holdings’ balance sheet?
Zooming in on the latest balance sheet data, we can see that DLH Holdings had a liability of $ 45.0 million due within 12 months and a liability of $ 71.5 million due beyond. On the other hand, he had cash of US $ 739.0K and US $ 37.6M in receivables due within one year. Its liabilities therefore total $ 78.2 million more than the combination of its cash and short-term receivables.
DLH Holdings has a market cap of $ 155.3 million, so it could most likely raise funds to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
DLH Holdings’ net debt stands at a very reasonable level of 2.1 times its EBITDA, while its EBIT only covered its interest expense 4.5 times last year. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. One way DLH Holdings could beat its debt would be to stop borrowing more but continue to increase its EBIT to around 19%, as it did last year. 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 DLH Holdings’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, DLH Holdings has actually generated more free cash flow than EBIT over the past three years. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
Fortunately, DLH Holdings’ impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. But, on a darker note, we’re a little concerned with its total liability level. Looking at all of the above factors together, it seems to us that DLH Holdings can manage its debt quite comfortably. On the plus side, this leverage can increase returns for shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. 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 off the balance sheet. For example, we discovered 1 warning sign for DLH Holdings which you should know before investing here.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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