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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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£3.60m at the end of September 2024, a reduction from UK£55.2m over a year. But on the other hand it also has UK£15.1m in cash, leading to a UK£11.5m net cash position.

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£63.7m falling due within a year, and liabilities of UK£10.7m due beyond that. Offsetting these obligations, it had cash of UK£15.1m as well as receivables valued at UK£77.3m due within 12 months. So it can boast UK£18.0m 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£7.05b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Auto Trader Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Auto Trader Group grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 82% 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£11.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in UK£298m. So is Auto Trader Group's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Auto Trader Group's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.