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.’ 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. We can see that Copart, Inc. (NASDAQ:CPRT) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Copart’s Net Debt?
As you can see below, at the end of July 2023, Copart had US$10.9m of debt, up from US$2.00m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$2.36b in cash, so it actually has US$2.35b net cash.
How Strong Is Copart’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Copart had liabilities of US$492.8m due within 12 months and liabilities of US$257.7m due beyond that. Offsetting this, it had US$2.36b in cash and US$708.6m in receivables that were due within 12 months. So it can boast US$2.32b more liquid assets than total liabilities.
This surplus suggests that Copart has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Copart boasts net cash, so it’s fair to say it does not have a heavy debt load!
Fortunately, Copart grew its EBIT by 8.1% in the last year, making that debt load look even more manageable. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Copart can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Copart 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, Copart recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Copart has net cash of US$2.35b, as well as more liquid assets than liabilities. So is Copart’s debt a risk? It doesn’t seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt.