DXC technology (NYSE: DXC) has a somewhat strained record

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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. Mostly, DXC Technology Company (NYSE: DXC) carries debt. But the real question is whether this debt makes the business risky.

When Is Debt a Problem?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

What is DXC Technology’s net debt?

The image below, which you can click for more details, shows DXC Technology owed US $ 4.62 billion in debt at the end of March 2021, down from $ 8.89 billion. US over one year. On the other hand, it has $ 2.97 billion in cash, resulting in net debt of around $ 1.65 billion.

NYSE: DXC Debt to Equity History June 6, 2021

A look at the responsibilities of DXC Technology

We can see from the most recent balance sheet that DXC Technology had US $ 8.15 billion in liabilities due within one year and US $ 8.58 billion in liabilities beyond. On the other hand, he had $ 2.97 billion in cash and $ 4.16 billion in receivables due within one year. It therefore has liabilities totaling US $ 9.61 billion more than its cash and short-term receivables combined.

This shortfall is sizable compared to its very large market capitalization of US $ 10.2 billion, so he suggests shareholders keep an eye on DXC Technology’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.

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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Given that net debt is only 0.93 times EBITDA, it is first surprising to see that DXC Technology’s EBIT has low interest coverage of 0.20 times. So while we are not necessarily alarmed, we think his debt is far from negligible. It is important to note that DXC Technology’s EBIT has fallen 97% over the past twelve months. If this earnings trend continues, paying off debt will be about as easy as driving cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether DXC Technology can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, DXC Technology has generated strong free cash flow equivalent to 69% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.

Our point of view

To be frank, DXC Technology’s interest coverage and track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Overall, we think it’s fair to say that DXC Technology has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. We have identified 1 warning sign with DXC technology, and understanding them should be part of your investment process.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares 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.

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