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We Think ASOS (LON:ASC) Can Stay On Top Of Its Debt

·4-min read

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies ASOS Plc (LON:ASC) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ASOS

How Much Debt Does ASOS Carry?

The image below, which you can click on for greater detail, shows that at August 2021 ASOS had debt of UK£463.2m, up from none in one year. But on the other hand it also has UK£662.7m in cash, leading to a UK£199.5m net cash position.


How Healthy Is ASOS' Balance Sheet?

We can see from the most recent balance sheet that ASOS had liabilities of UK£998.0m falling due within a year, and liabilities of UK£852.5m due beyond that. Offsetting this, it had UK£662.7m in cash and UK£66.4m in receivables that were due within 12 months. So its liabilities total UK£1.12b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because ASOS is worth UK£2.37b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, ASOS also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, ASOS grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ASOS 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. ASOS may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, ASOS recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although ASOS'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£199.5m. And it impressed us with its EBIT growth of 27% over the last year. So we don't have any problem with ASOS's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - ASOS has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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