Is Aarvee Denims and Exports (NSE:AARVEEDEN) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Aarvee Denims and Exports Ltd. (NSE:AARVEEDEN) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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 ₹3.90b in debt in September 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Aarvee Denims and Exports' Balance Sheet?

The latest balance sheet data shows that Aarvee Denims and Exports had liabilities of ₹2.99b due within a year, and liabilities of ₹1.78b falling due after that. Offsetting these obligations, it had cash of ₹75.0m as well as receivables valued at ₹1.42b due within 12 months. So it has liabilities totalling ₹3.27b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹408.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Aarvee Denims and Exports would probably need a major re-capitalization if its creditors were to demand repayment. 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.

Over 12 months, Aarvee Denims and Exports made a loss at the EBIT level, and saw its revenue drop to ₹3.2b, which is a fall of 30%. That makes us nervous, to say the least.

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). Indeed, it lost a very considerable ₹495m at the EBIT level. 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 ₹806m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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. We've identified 2 warning signs with Aarvee Denims and Exports , and understanding them should be part of your investment process.

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.