Warren Buffett famously said, “Volatility is not synonymous with risk.”When I think about how risky a company is, I always like to look to the use of debt as too much debt can lead to bankruptcy. Advance Auto Parts Co., Ltd. (NYSE:AAP) has debt on its balance sheet. But the real question is whether this debt puts the company at risk.
What are the risks of borrowing?
Debt and other liabilities become dangerous to a business when it cannot easily meet these obligations through free cash flow or raising capital at an attractive price. Ultimately, shareholders may walk away with nothing if the company fails to meet its legal obligations to repay its debts. But the more common (but still painful) scenario is that shareholders are permanently diluted as they have to raise new capital at a lower price. Of course, debt can be an important tool in business, especially in capital-heavy ones. When we think about the use of corporate debt, we first consider cash and debt together.
Check out the latest analysis from Advance Auto Parts.
What is Advance Auto Parts’ net debt?
You can click the chart below for historical figures, but as of October 2022, we can see that Advance Auto Parts’ debt was US$1.37 billion, up from US$1.03 billion over the course of the year. However, with cash reserves of $191.2 million, net debt is low at approximately $1.18 billion.
How healthy is Advance Auto Parts’ balance sheet?
The latest balance sheet shows that Advance Auto Parts had US$5.44 billion of debt due within one year and US$3.97 billion of debt thereafter. Offsetting these debts were US$191.2 million in cash and US$845.7 million of his receivables due within 12 months. As such, the company’s debt is US$8.38 billion more than its combined cash and short-term receivables.
This deficit is significant compared to a market capitalization of US$9.22 billion, suggesting that shareholders should be careful with Advance Auto Parts’ use of debt. Shareholders could face severe dilution if lenders demand a stronger balance sheet.
We primarily use two ratios to show the level of debt to income. The first is Net Debt divided by Earnings Before Interest, Taxes, Depreciation, Amortization (EBITDA) and the second is Earnings Before Interest and Taxes (EBIT) equals interest expense (or interest for short). cover) is the number of times to cover. In this way we consider both the absolute amount of debt and the interest paid on it.
Advance Auto Parts’ net debt is only 1.2 times EBITDA. And that his EBIT is 16.3 times the size, easily covering interest expense. Thus, it can be argued that elephants are no more threatened by debt than rats are. In fact, the saving grace for Advance Auto Parts is its low debt levels, as its EBIT has fallen 23% over the last 12 months. Declining earnings (if this trend continues) can eventually make even modest debt very risky. We arguably learn the most about debt from the balance sheet. . But whether Advance Auto Parts can strengthen its balance sheet over time will ultimately depend on the future profitability of the business.If you want to know the opinion of experts This free report on analyst profit forecasts is interesting.
Finally, tax officials may adore accounting benefits, but lenders only accept cold cash. A logical step, therefore, is to look at the percentage of her EBIT that matches the actual free cash flow. Over the past three years, Advance Auto Parts has generated strong free cash flow representing 63% of EBIT, as expected. This cold cash means you can reduce your debt when you need it.
Neither Advance Auto Parts’ ability to grow EBIT nor its level of total debt gave confidence in its ability to take on more debt. But the good news is that EBIT appears to easily cover the interest expense. Given all the factors discussed, Advance Auto Parts appears to be taking risks with its debt. That debt could boost returns, but we think the company has plenty of leverage right now. The balance sheet is clearly an area to focus on when analyzing liabilities. However, not all investment risks are on the balance sheet, far from it. Identified two warning signs With advanced auto parts and understanding them should be part of the investment process.
After all, sometimes it’s easier to focus on companies that don’t require debt.the reader is List of growth stocks with zero net debt. 100% freejust now.
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This article by Simply Wall St is general in nature. We provide comments based on historical data and analyst projections using only unbiased methodologies and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. We aim to deliver long-term focused analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Is not …