Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Auto Trader Group plc (LON:AUTO) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Auto Trader Group
How Much Debt Does Auto Trader Group Carry?
You can click the graphic below for the historical numbers, but it shows that Auto Trader Group had UK£27.6m of debt in March 2021, down from UK£310.5m, one year before. However, its balance sheet shows it holds UK£45.7m in cash, so it actually has UK£18.1m net cash.
How Healthy Is Auto Trader Group’s Balance Sheet?
According to the last reported balance sheet, Auto Trader Group had liabilities of UK£24.8m due within 12 months, and liabilities of UK£51.0m due beyond 12 months. On the other hand, it had cash of UK£45.7m and UK£59.9m worth of receivables due within a year. So it actually has UK£29.8m more liquid assets than total liabilities.
This state of affairs indicates that Auto Trader Group’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it’s hard to imagine that the UK£6.27b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Succinctly put, Auto Trader Group boasts net cash, so it’s fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Auto Trader Group if management cannot prevent a repeat of the 38% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Auto Trader Group’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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Auto Trader Group 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. During the last three years, Auto Trader Group generated free cash flow amounting to a very robust 81% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Auto Trader Group has net cash of UK£18.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in UK£123m. So we don’t have any problem with Auto Trader Group’s use of debt. Over time, share prices tend to follow earnings per share, so if you’re interested in Auto Trader Group, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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