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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Domain Holdings Australia Limited (ASX: DHG) carries the debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
See our latest review for Domain Holdings Australia
What is Domain Holdings Australia’s net debt?
The graph below, which you can click for more details, shows that Domain Holdings Australia had A $ 173.1 million in debt as of June 2021; about the same as the year before. However, he has A $ 94.2 million in cash offsetting this, leading to net debt of around A $ 79.0 million.
A look at the responsibilities of Domain Holdings Australia
Zooming in on the latest balance sheet data, we can see that Domain Holdings Australia had a liability of A $ 74.2 million due within 12 months and a liability of A $ 273.4 million beyond. On the other hand, he had A $ 94.2 million in cash and A $ 52.6 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by A $ 200.9 million.
Given that Domain Holdings Australia has a market capitalization of AU $ 3.30 billion, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s indebtedness relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With net debt of just 1.1x EBITDA, Domain Holdings Australia is arguably fairly cautious. And this view is supported by the strong interest coverage, with EBIT reaching 9.7 times last year’s interest expense. On top of that, we are happy to report that Domain Holdings Australia has increased its EBIT by 41%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Domain Holdings Australia can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Domain Holdings Australia has recorded free cash flow totaling 88% of its EBIT, which is higher than what we usually expected. This puts him in a very strong position to pay off the debt.
Our point of view
Domain Holdings Australia’s EBIT conversion into free cash flow suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Overall, we don’t think Domain Holdings Australia is taking bad risks, as its leverage appears modest. The balance sheet therefore seems rather healthy to us. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you have understood this as well, you are in luck because today you can check out this interactive historical earnings per share chart of Domain Holdings Australia for free.
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.
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