We Think Avalon Advanced Materials (TSE:AVL) Has A Fair Chunk Of Debt

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. Importantly, Avalon Advanced Materials Inc. (TSE:AVL) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Avalon Advanced Materials

What Is Avalon Advanced Materials's Debt?

You can click the graphic below for the historical numbers, but it shows that as of February 2021 Avalon Advanced Materials had CA$3.60m of debt, an increase on CA$197.5k, over one year. However, it also had CA$3.38m in cash, and so its net debt is CA$223.0k.

A Look At Avalon Advanced Materials' Liabilities

According to the last reported balance sheet, Avalon Advanced Materials had liabilities of CA$1.08m due within 12 months, and liabilities of CA$7.35m due beyond 12 months. Offsetting this, it had CA$3.38m in cash and CA$174.8k in receivables that were due within 12 months. So its liabilities total CA$4.88m more than the combination of its cash and short-term receivables.

Since publicly traded Avalon Advanced Materials shares are worth a total of CA$60.4m, 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. Carrying virtually no net debt, Avalon Advanced Materials has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Avalon Advanced Materials 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.

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$7.6m. 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$2.2m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. For example Avalon Advanced Materials has 6 warning signs (and 2 which are significant) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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