Here's Why Avalon Advanced Materials (TSE:AVL) Can Afford Some Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Avalon Advanced Materials Inc. (TSE:AVL) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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.

Check out 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 2021 Avalon Advanced Materials had debt of CA$3.42m, up from CA$58.3k in one year. However, it also had CA$2.71m in cash, and so its net debt is CA$708.9k.

How Strong Is Avalon Advanced Materials' Balance Sheet?

The latest balance sheet data shows that Avalon Advanced Materials had liabilities of CA$889.5k due within a year, and liabilities of CA$5.42m falling due after that. Offsetting these obligations, it had cash of CA$2.71m as well as receivables valued at CA$159.5k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$3.44m.

Given Avalon Advanced Materials has a market capitalization of CA$50.8m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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! There's no doubt that we learn most about debt from the balance sheet. But it is Avalon Advanced Materials's earnings that will influence how the balance sheet holds up in the future. 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.

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

Caveat Emptor

While Avalon Advanced Materials's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CA$7.7m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CA$2.8m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 6 warning signs we've spotted with Avalon Advanced Materials (including 2 which are significant) .

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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