Does Avalon Advanced Materials (TSE:AVL) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Avalon Advanced Materials Inc. (TSE:AVL) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Avalon Advanced Materials

How Much Debt Does Avalon Advanced Materials Carry?

The image below, which you can click on for greater detail, shows that at May 2022 Avalon Advanced Materials had debt of CA$4.67m, up from CA$3.42m in one year. However, it does have CA$4.12m in cash offsetting this, leading to net debt of about CA$546.8k.

How Strong Is Avalon Advanced Materials' Balance Sheet?

According to the last reported balance sheet, Avalon Advanced Materials had liabilities of CA$1.99m due within 12 months, and liabilities of CA$4.61m due beyond 12 months. On the other hand, it had cash of CA$4.12m and CA$66.6k worth of receivables due within a year. So its liabilities total CA$2.41m more than the combination of its cash and short-term receivables.

Of course, Avalon Advanced Materials has a market capitalization of CA$48.3m, 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. But either way, Avalon Advanced Materials has virtually no net debt, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Avalon Advanced Materials 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.

Since Avalon Advanced Materials has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Not only did Avalon Advanced Materials's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CA$2.7m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$3.1m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. Case in point: We've spotted 4 warning signs for Avalon Advanced Materials you should be aware of, and 2 of them shouldn't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.