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. Importantly, Asbury Automotive Group, Inc. (NYSE:ABG) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is Asbury Automotive Group’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Asbury Automotive Group had US$1.92b of debt, an increase on US$1.83b, over one year. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Asbury Automotive Group’s Balance Sheet?
According to the last reported balance sheet, Asbury Automotive Group had liabilities of US$1.27b due within 12 months, and liabilities of US$985.1m due beyond 12 months. Offsetting these obligations, it had cash of US$9.60m as well as receivables valued at US$117.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.13b.
When you consider that this deficiency exceeds the company’s US$1.78b market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner’s social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Asbury Automotive Group has a rather high debt to EBITDA ratio of 5.3 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. Fortunately, Asbury Automotive Group grew its EBIT by 8.4% in the last year, slowly shrinking its debt relative to earnings. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Asbury Automotive Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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. In the last three years, Asbury Automotive Group’s free cash flow amounted to 39% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
On the face of it, Asbury Automotive Group’s level of total liabilities left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Asbury Automotive Group’s use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. In light of our reservations about the company’s balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.