Here's Why Australian Dairy Nutritionals Group (ASX:AHF) Can Afford Some Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Australian Dairy Nutritionals Group (ASX:AHF) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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.

See our latest analysis for Australian Dairy Nutritionals Group

What Is Australian Dairy Nutritionals Group's Debt?

As you can see below, Australian Dairy Nutritionals Group had AU$12.1m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of AU$6.40m, its net debt is less, at about AU$5.68m.

A Look At Australian Dairy Nutritionals Group's Liabilities

The latest balance sheet data shows that Australian Dairy Nutritionals Group had liabilities of AU$15.2m due within a year, and liabilities of AU$639.1k falling due after that. Offsetting these obligations, it had cash of AU$6.40m as well as receivables valued at AU$2.15m due within 12 months. So it has liabilities totalling AU$7.25m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Australian Dairy Nutritionals Group is worth AU$32.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Australian Dairy Nutritionals Group will need earnings to service that debt. 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 Australian Dairy Nutritionals Group wasn't profitable at an EBIT level, but managed to grow its revenue by 5.1%, to AU$22m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Australian Dairy Nutritionals Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$4.9m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$3.6m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Take risks, for example - Australian Dairy Nutritionals Group has 3 warning signs (and 1 which is significant) we think you should know about.

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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