These 4 metrics indicate that AO World (LON: AO.) Is using debt intensively
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies AO World plc (LON: AO.) Uses debt. But does this debt worry shareholders?
When is Debt a Problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first look at cash and debt levels, together.
See our latest analysis for AO World
What is AO World’s debt?
As you can see below, AO World was in debt of £ 20.0million, as of September 2021, which is roughly the same as the year before. You can click on the graph for more details. However, since he has a cash reserve of £ 11.1million, his net debt is less, at around £ 8.90million.
How strong is AO World’s balance sheet?
The most recent balance sheet shows that AO World had liabilities of £ 371.2million maturing within one year and liabilities of £ 84.7million beyond. In compensation for these obligations, it had cash of £ 11.1 million as well as receivables valued at £ 176.8 million maturing within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by £ 268.0 million.
This deficit is not that big as AO World is worth £ 480.3million and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
AO World has a very low debt to EBITDA ratio of 0.50 so it is strange to see low interest coverage as last year’s EBIT was only 0.98 times interest expense. So while we are not necessarily alarmed, we believe his debt is far from negligible. It is important to note that AO World’s EBIT has fallen 82% over the past twelve months. If this decline continues, it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether AO World can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, AO World has actually generated more free cash flow than EBIT over the past two years. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
As AO World’s EBIT growth rate makes us nervous. For example, its conversion from EBIT to free cash flow and from net debt to EBITDA gives us some confidence in its ability to manage its debt. Taking the factors mentioned above together, we believe that AO World’s debt presents certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you need to know the 1 warning sign we spotted with AO World.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.