Auto Trader Group (LON:AUTO) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Auto Trader Group plc (LON:AUTO) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Auto Trader Group

What Is Auto Trader Group's Net Debt?

The image below, which you can click on for greater detail, shows that Auto Trader Group had debt of UK£29.8m at the end of March 2024, a reduction from UK£61.6m over a year. However, it also had UK£18.7m in cash, and so its net debt is UK£11.1m.

A Look At Auto Trader Group's Liabilities

According to the last reported balance sheet, Auto Trader Group had liabilities of UK£63.3m due within 12 months, and liabilities of UK£42.4m due beyond 12 months. On the other hand, it had cash of UK£18.7m and UK£77.2m worth of receivables due within a year. So its liabilities total UK£9.80m more than the combination of its cash and short-term receivables.

Having regard to Auto Trader Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the UK£7.92b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Auto Trader Group has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Auto Trader Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.03 and EBIT of 102 times the interest expense. So relative to past earnings, the debt load seems trivial. And we also note warmly that Auto Trader Group grew its EBIT by 14% 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 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Auto Trader Group generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Auto Trader Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Auto Trader Group is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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.