Does Domain Holdings Australia (ASX:DHG) use too much debt?

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Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Domain Holdings Australia Limited (ASX:DHG) uses debt in its business. But does this debt worry shareholders?

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for Domain Holdings Australia

How much debt does Domain Holdings Australia have?

As you can see below, at the end of December 2021, Domain Holdings Australia had A$219.0 million in debt, up from A$172.1 million a year ago. Click on the image for more details. However, he also had A$52.6 million in cash, so his net debt is A$166.4 million.

ASX: Debt to Equity History DHG March 14, 2022

How healthy is Domain Holdings Australia’s balance sheet?

The latest balance sheet data shows Domain Holdings Australia had liabilities of A$76.9 million due within one year, and liabilities of A$317.2 million falling due thereafter. As compensation for these obligations, it had cash of A$52.6 million and receivables valued at A$50.1 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of A$291.4 million.

Of course, Domain Holdings Australia has a market capitalization of A$2.31 billion, so those liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Domain Holdings Australia’s net debt to EBITDA ratio of around 2.0 suggests only moderate use of debt. And its towering EBIT of 11.5 times its interest expense means that the debt burden is as light as a peacock feather. It’s worth noting that Domain Holdings Australia’s EBIT jumped like bamboo after rain, gaining 34% in the last twelve months. This will make it easier to manage your debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Domain Holdings Australia can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Domain Holdings Australia has had free cash flow of 78% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Domain Holdings Australia’s EBIT growth rate suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we don’t think Domain Holdings Australia is taking bad risks, as its leverage looks modest. The balance sheet therefore seems rather healthy to us. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 1 warning sign for Domain Holdings Australia which you should be aware of before investing here.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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