Is xReality Group (ASX:XRG) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, xReality Group Limited (ASX:XRG) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

The image below, which you can click on for greater detail, shows that at June 2024 xReality Group had debt of AU$8.66m, up from AU$7.58m in one year. On the flip side, it has AU$1.37m in cash leading to net debt of about AU$7.30m.

A Look At xReality Group's Liabilities

We can see from the most recent balance sheet that xReality Group had liabilities of AU$6.49m falling due within a year, and liabilities of AU$26.7m due beyond that. On the other hand, it had cash of AU$1.37m and AU$2.52m worth of receivables due within a year. So its liabilities total AU$29.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the AU$19.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, xReality Group would likely require a major re-capitalisation if it had to pay its creditors today. 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.

Over 12 months, xReality Group made a loss at the EBIT level, and saw its revenue drop to AU$10m, which is a fall of 2.9%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months xReality Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$2.4m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through AU$2.3m in negative free cash flow over the last year. So suffice it to say we consider the stock to be 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. For example, we've discovered 5 warning signs for xReality Group (2 are significant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.