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. We can see that AO World plc (LON:AO.) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for AO World
What Is AO World's Net Debt?
The image below, which you can click on for greater detail, shows that AO World had debt of UK£20.8m at the end of September 2020, a reduction from UK£35.4m over a year. But on the other hand it also has UK£85.4m in cash, leading to a UK£64.6m net cash position.
How Healthy Is AO World's Balance Sheet?
The latest balance sheet data shows that AO World had liabilities of UK£405.4m due within a year, and liabilities of UK£84.4m falling due after that. Offsetting this, it had UK£85.4m in cash and UK£165.7m in receivables that were due within 12 months. So it has liabilities totalling UK£238.7m more than its cash and near-term receivables, combined.
Of course, AO World has a market capitalization of UK£2.03b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, AO World boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, AO World turned things around in the last 12 months, delivering and EBIT of UK£26m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AO World 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. While AO World has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, AO World actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
Although AO World's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£64.6m. The cherry on top was that in converted 345% of that EBIT to free cash flow, bringing in UK£90m. So we don't have any problem with AO World's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for AO World you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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About LSE:AO.
AO World
Engages in the online retailing of domestic appliances and ancillary services in the United Kingdom and Germany.
Excellent balance sheet with reasonable growth potential.
