Is Avalon Technologies (NSE:AVALON) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Avalon Technologies Limited (NSE:AVALON) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Avalon Technologies

How Much Debt Does Avalon Technologies Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Avalon Technologies had ₹1.99b of debt, an increase on ₹1.36b, over one year. However, it also had ₹1.88b in cash, and so its net debt is ₹108.2m.

How Healthy Is Avalon Technologies' Balance Sheet?

According to the last reported balance sheet, Avalon Technologies had liabilities of ₹3.17b due within 12 months, and liabilities of ₹864.1m due beyond 12 months. Offsetting these obligations, it had cash of ₹1.88b as well as receivables valued at ₹2.41b due within 12 months. So it actually has ₹267.6m more liquid assets than total liabilities.

This state of affairs indicates that Avalon Technologies' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹50.7b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Avalon Technologies has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Avalon Technologies's low debt to EBITDA ratio of 0.14 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. The bad news is that Avalon Technologies saw its EBIT decline by 12% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Avalon Technologies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Avalon Technologies burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Avalon Technologies's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its net debt to EBITDA was re-invigorating. We think that Avalon Technologies's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.