Some say that volatility is the best way to think about risk as an investor, rather than liability, but Warren Buffett famously said, “Volatility is not synonymous with risk.” So smart rich people seem to know that debt (usually associated with bankruptcy) is a very important factor in assessing a company’s risk. Importantly, Advance Auto Parts Co., Ltd. (NYSE:AAP) is in debt. But the real question is whether this debt puts the company at risk.
When does debt become a problem
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. Part of capitalism is the process of ‘creative destruction’ in which failed businesses are ruthlessly liquidated by bankers. Although less common, we often see debt companies permanently diluting their shareholders. Of course, debt can be an important tool in business, especially in capital-heavy ones. The first step in considering a company’s debt level is to look at cash and debt together.
See the latest analysis of Advance Auto Parts
What is Advance Auto Parts’ net debt?
As shown below, at the end of July 2022, Advance Auto Parts had $1.29 billion in debt, up from $103 million a year ago. Click the image for details. But he also had US$240.6 million in cash, so his net debt is US$1.05 billion.
How healthy is Advance Auto Parts’ balance sheet?
The latest balance sheet data show that Advance Auto Parts had $5.34 billion of debt within a year and $4 billion of debt thereafter. On the other hand, there was US$240.6 million in cash and US$930.5 million worth of his receivables to be paid within a year. As such, the company’s debt is US$8.17 billion more than its cash and short-term receivables combined.
This is a ton of leverage, even compared to the massive US$11.3 billion market cap. Shareholders could face severe dilution if lenders demand a stronger balance sheet.
To size a company’s liabilities relative to its revenues, divide net debt by earnings before interest, taxes, depreciation and amortization (EBITDA), and divide earnings before interest and taxes (EBIT) by interest expense. (its interest 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 0.99 times EBITDA. And that EBIT covers interest expense more than a whopping 19.0 times. So I’m pretty relaxed about using very conservative debt. But the bad news is that his EBIT for Advance Auto Parts has plummeted 19% in the last 12 months. We believe that frequent repeats of hat-like performance can lead to inventory difficulties. Clearly, the balance sheet is the starting point when analyzing debt levels. But whether Advance Auto Parts can strengthen its balance sheet over time will ultimately depend on the future profitability of the business.So if you are focused on the future check this out freedom A report that shows an analyst’s profit forecast.
Finally, companies can pay off their debt only with cold cash, not with accounting profits. So we’re always looking at how much of that EBIT translates into free cash flow. In the last three years, Advance Auto Parts posted free cash flow equivalent to 66% of his EBIT. This is almost normal given that free cash flow excludes interest and taxes. This free cash flow allows the company to repay its debt if it needs to.
our view
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 its interest cover tells a whole different story, suggesting some resilience. From all the above angles, Advance Auto Parts appears to be a slightly riskier investment as a result of the debt. This isn’t necessarily a bad thing, as leverage can boost stock returns, but it’s something to be aware of. Clearly, the balance sheet is the starting point when analyzing debt levels. Ultimately, however, all companies may have the risk of existing off balance sheets. Notice that Advance Auto Parts is listed One Warning Sign in Investment Analysis what you should know…
Check this out if you’re interested in investing in a profitable business without debt. freedom List of growth companies with net cash on their balance sheets.
Valuation is complicated, but we’re here to help make it simple.
find out if advance auto parts You may be overestimated or underestimated by checking out our comprehensive analysis including: Fair value estimates, risks and warnings, dividends, insider trading and financial health.
See Free Analysis
Do you have feedback on this article? What interests you? contact directly with us. Or send an email to our editorial team (at) Simplywallst.com.
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 …