Here's Why xReality Group (ASX:XRG) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, xReality Group Limited (ASX:XRG) does carry 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for xReality Group

What Is xReality Group's Net Debt?

As you can see below, xReality Group had AU$7.67m of debt at December 2021, down from AU$10.5m a year prior. On the flip side, it has AU$1.94m in cash leading to net debt of about AU$5.73m.

How Strong Is xReality Group's Balance Sheet?

We can see from the most recent balance sheet that xReality Group had liabilities of AU$3.45m falling due within a year, and liabilities of AU$20.4m due beyond that. On the other hand, it had cash of AU$1.94m and AU$541.4k worth of receivables due within a year. So its liabilities total AU$21.3m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$26.9m, so it does suggest shareholders should keep an eye on xReality Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is xReality Group'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 xReality Group wasn't profitable at an EBIT level, but managed to grow its revenue by 21%, to AU$6.2m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, xReality Group still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$1.8m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$216k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with xReality Group (including 1 which is a bit concerning) .

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.

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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.