Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies AutoWeb, Inc. (NASDAQ:AUTO) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does AutoWeb Carry?
The image below, which you can click on for greater detail, shows that at March 2021 AutoWeb had debt of US$10.3m, up from US$6.71m in one year. However, its balance sheet shows it holds US$11.2m in cash, so it actually has US$901.0k net cash.
How Healthy Is AutoWeb’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that AutoWeb had liabilities of US$21.5m due within 12 months and liabilities of US$1.99m due beyond that. On the other hand, it had cash of US$11.2m and US$13.9m worth of receivables due within a year. So it actually has US$1.64m more liquid assets than total liabilities.
This surplus suggests that AutoWeb has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that AutoWeb has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AutoWeb can strengthen its balance sheet over time.
In the last year AutoWeb had a loss before interest and tax, and actually shrunk its revenue by 35%, to US$70m. That makes us nervous, to say the least.
So How Risky Is AutoWeb?
While AutoWeb lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$2.6m. So although it is loss-making, it doesn’t seem to have too much near-term balance sheet risk, keeping in mind the net cash. We’ll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet.