AO World (LON:AO.) Is Making Moderate Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that AO World plc (LON:AO.) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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 AO World

How Much Debt Does AO World Carry?

As you can see below, at the end of September 2022, AO World had UK£55.0m of debt, up from UK£20.0m a year ago. Click the image for more detail. However, it does have UK£42.9m in cash offsetting this, leading to net debt of about UK£12.1m.

How Strong Is AO World's Balance Sheet?

We can see from the most recent balance sheet that AO World had liabilities of UK£339.1m falling due within a year, and liabilities of UK£78.1m due beyond that. Offsetting these obligations, it had cash of UK£42.9m as well as receivables valued at UK£120.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£254.3m.

This is a mountain of leverage relative to its market capitalization of UK£341.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 AO World'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.

Over 12 months, AO World made a loss at the EBIT level, and saw its revenue drop to UK£1.4b, which is a fall of 10%. We would much prefer see growth.

Caveat Emptor

While AO World's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at UK£27m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled UK£11m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for AO World 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.