Health Check: How Prudently Does Aarvee Denims and Exports (NSE:AARVEEDEN) Use 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.' 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 Aarvee Denims and Exports Limited (NSE:AARVEEDEN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Aarvee Denims and Exports

What Is Aarvee Denims and Exports's Net Debt?

The chart below, which you can click on for greater detail, shows that Aarvee Denims and Exports had ₹4.20b in debt in March 2021; about the same as the year before. However, because it has a cash reserve of ₹206.4m, its net debt is less, at about ₹4.00b.

How Strong Is Aarvee Denims and Exports' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Aarvee Denims and Exports had liabilities of ₹3.66b due within 12 months and liabilities of ₹1.77b due beyond that. On the other hand, it had cash of ₹206.4m and ₹2.08b worth of receivables due within a year. So its liabilities total ₹3.14b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹480.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Aarvee Denims and Exports would likely require a major re-capitalisation if it had to pay its creditors today. 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 Aarvee Denims and Exports 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.

In the last year Aarvee Denims and Exports had a loss before interest and tax, and actually shrunk its revenue by 49%, to ₹2.9b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Aarvee Denims and Exports's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₹321m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost ₹642m in the last year. So we think buying this stock is 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. Be aware that Aarvee Denims and Exports is showing 2 warning signs in our investment analysis , 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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This article by Simply Wall St is general in nature. 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.
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