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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Avenira Limited (ASX:AEV) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Avenira's Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Avenira had debt of AU$2.48m, up from none in one year. But on the other hand it also has AU$3.12m in cash, leading to a AU$643.0k net cash position.
A Look At Avenira's Liabilities
The latest balance sheet data shows that Avenira had liabilities of AU$640.1k due within a year, and liabilities of AU$4.26m falling due after that. Offsetting this, it had AU$3.12m in cash and AU$129.2k in receivables that were due within 12 months. So its liabilities total AU$1.65m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Avenira is worth AU$6.90m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Avenira also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Avenira will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Given its lack of meaningful operating revenue, investors are probably hoping that Avenira finds some valuable resources, before it runs out of money.
So How Risky Is Avenira?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Avenira had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$2.9m of cash and made a loss of AU$2.1m. With only AU$643.0k on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Avenira has 2 warning signs we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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