Auto Trader Group (LON:AUTO) Could Easily Take On More Debt

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.' 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, Auto Trader Group plc (LON:AUTO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Auto Trader Group

What Is Auto Trader Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Auto Trader Group had UK£73.9m of debt, an increase on none, over one year. However, it does have UK£17.6m in cash offsetting this, leading to net debt of about UK£56.3m.

How Strong Is Auto Trader Group's Balance Sheet?

We can see from the most recent balance sheet that Auto Trader Group had liabilities of UK£57.3m falling due within a year, and liabilities of UK£96.4m due beyond that. Offsetting these obligations, it had cash of UK£17.6m as well as receivables valued at UK£68.1m due within 12 months. So it has liabilities totalling UK£68.0m more than its cash and near-term receivables, combined.

Having regard to Auto Trader Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the UK£5.51b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Auto Trader Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Auto Trader Group's net debt is only 0.18 times its EBITDA. And its EBIT easily covers its interest expense, being 151 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Auto Trader Group has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Auto Trader Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Auto Trader Group generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Auto Trader Group's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It looks Auto Trader Group has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. 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.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.