Is Avalon Advanced Materials (TSE:AVL) A Risky Investment?

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 can see that Avalon Advanced Materials Inc. (TSE:AVL) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Avalon Advanced Materials

How Much Debt Does Avalon Advanced Materials Carry?

You can click the graphic below for the historical numbers, but it shows that as of May 2022 Avalon Advanced Materials had CA$4.67m of debt, an increase on CA$3.42m, over one year. However, because it has a cash reserve of CA$4.12m, its net debt is less, at about CA$546.8k.

How Strong Is Avalon Advanced Materials' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Avalon Advanced Materials had liabilities of CA$1.99m due within 12 months and liabilities of CA$4.61m due beyond that. Offsetting this, it had CA$4.12m in cash and CA$66.6k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$2.41m.

Given Avalon Advanced Materials has a market capitalization of CA$47.8m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Avalon Advanced Materials has a very light debt load indeed. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Given its lack of meaningful operating revenue, investors are probably hoping that Avalon Advanced Materials finds some valuable resources, before it runs out of money.

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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$3.1m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Avalon Advanced Materials (including 2 which are a bit unpleasant) .

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.