We Think REA Group (ASX:REA) Can Manage Its Debt With Ease

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that REA Group Limited (ASX:REA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for REA Group

What Is REA Group's Debt?

As you can see below, at the end of December 2023, REA Group had AU$398.3m of debt, up from AU$316.7m a year ago. Click the image for more detail. However, it also had AU$340.5m in cash, and so its net debt is AU$57.8m.

How Healthy Is REA Group's Balance Sheet?

According to the last reported balance sheet, REA Group had liabilities of AU$321.1m due within 12 months, and liabilities of AU$837.8m due beyond 12 months. On the other hand, it had cash of AU$340.5m and AU$392.5m worth of receivables due within a year. So its liabilities total AU$425.9m more than the combination of its cash and short-term receivables.

Having regard to REA Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$26.2b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, REA Group has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With debt at a measly 0.09 times EBITDA and EBIT covering interest a whopping 44.1 times, it's clear that REA Group is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. And we also note warmly that REA Group grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine REA Group's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, REA Group recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, REA Group's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think REA Group's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for REA Group that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com