Is AD1 Holdings (ASX:AD1) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, AD1 Holdings Limited (ASX:AD1) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for AD1 Holdings

What Is AD1 Holdings's Net Debt?

As you can see below, at the end of December 2021, AD1 Holdings had AU$3.83m of debt, up from none a year ago. Click the image for more detail. However, it does have AU$4.62m in cash offsetting this, leading to net cash of AU$783.2k.

How Healthy Is AD1 Holdings' Balance Sheet?

We can see from the most recent balance sheet that AD1 Holdings had liabilities of AU$4.84m falling due within a year, and liabilities of AU$3.63m due beyond that. Offsetting this, it had AU$4.62m in cash and AU$1.97m in receivables that were due within 12 months. So its liabilities total AU$1.88m more than the combination of its cash and short-term receivables.

Since publicly traded AD1 Holdings shares are worth a total of AU$9.46m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, AD1 Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since AD1 Holdings 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.

Over 12 months, AD1 Holdings reported revenue of AU$6.3m, which is a gain of 66%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is AD1 Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months AD1 Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$3.1m and booked a AU$2.7m accounting loss. Given it only has net cash of AU$783.2k, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, AD1 Holdings may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. 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. For instance, we've identified 4 warning signs for AD1 Holdings (1 makes us a bit uncomfortable) you should be aware of.

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.