Here's Why Allegra Orthopaedics (ASX:AMT) 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. Importantly, Allegra Orthopaedics Limited (ASX:AMT) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Allegra Orthopaedics

What Is Allegra Orthopaedics's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Allegra Orthopaedics had debt of AU$2.20m, up from AU$294.8k in one year. However, because it has a cash reserve of AU$206.3k, its net debt is less, at about AU$1.99m.

A Look At Allegra Orthopaedics' Liabilities

Zooming in on the latest balance sheet data, we can see that Allegra Orthopaedics had liabilities of AU$1.58m due within 12 months and liabilities of AU$1.90m due beyond that. Offsetting this, it had AU$206.3k in cash and AU$1.20m in receivables that were due within 12 months. So it has liabilities totalling AU$2.07m more than its cash and near-term receivables, combined.

Of course, Allegra Orthopaedics has a market capitalization of AU$13.6m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Allegra Orthopaedics's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Allegra Orthopaedics made a loss at the EBIT level, and saw its revenue drop to AU$3.9m, which is a fall of 38%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Allegra Orthopaedics'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 AU$2.4m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$2.0m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Allegra Orthopaedics (at least 4 which are concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.