Is Aarvee Denims and Exports (NSE:AARVEEDEN) Using Debt Sensibly?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Aarvee Denims and Exports Limited (NSE:AARVEEDEN) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Aarvee Denims and Exports

What Is Aarvee Denims and Exports's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Aarvee Denims and Exports had ₹4.11b of debt in March 2020, down from ₹4.34b, one year before. However, because it has a cash reserve of ₹171.7m, its net debt is less, at about ₹3.94b.

A Look At Aarvee Denims and Exports's Liabilities

The latest balance sheet data shows that Aarvee Denims and Exports had liabilities of ₹4.47b due within a year, and liabilities of ₹1.65b falling due after that. Offsetting these obligations, it had cash of ₹171.7m as well as receivables valued at ₹2.35b due within 12 months. So it has liabilities totalling ₹3.6b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹290.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Aarvee Denims and Exports would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Aarvee Denims and Exports's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Aarvee Denims and Exports had a loss before interest and tax, and actually shrunk its revenue by 25%, to ₹5.6b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Aarvee Denims and Exports's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₹42.8m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost ₹419.3m in the last year. So we think buying this stock is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Aarvee Denims and Exports you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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