Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Albena AD (BUL:6AB) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Albena AD's Debt?
The chart below, which you can click on for greater detail, shows that Albena AD had лв103.7m in debt in September 2020; about the same as the year before. However, because it has a cash reserve of лв18.2m, its net debt is less, at about лв85.6m.
How Healthy Is Albena AD's Balance Sheet?
The latest balance sheet data shows that Albena AD had liabilities of лв25.3m due within a year, and liabilities of лв134.6m falling due after that. Offsetting these obligations, it had cash of лв18.2m as well as receivables valued at лв5.28m due within 12 months. So it has liabilities totalling лв136.5m more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of лв111.7m, we think shareholders really should watch Albena AD's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Albena AD will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Albena AD made a loss at the EBIT level, and saw its revenue drop to лв50m, which is a fall of 59%. To be frank that doesn't bode well.
While Albena AD's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable лв20m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through лв5.9m in negative free cash flow over the last year. So suffice it to say we consider the stock to be 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Albena AD (of which 1 is a bit unpleasant!) you should know about.
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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