Is Adventa Berhad (KLSE:ADVENTA) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Adventa Berhad (KLSE:ADVENTA) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Adventa Berhad

What Is Adventa Berhad's Net Debt?

As you can see below, at the end of September 2020, Adventa Berhad had RM21.7m of debt, up from RM15.9m a year ago. Click the image for more detail. On the flip side, it has RM12.6m in cash leading to net debt of about RM9.14m.

How Healthy Is Adventa Berhad's Balance Sheet?

According to the last reported balance sheet, Adventa Berhad had liabilities of RM27.4m due within 12 months, and liabilities of RM370.0k due beyond 12 months. Offsetting this, it had RM12.6m in cash and RM30.1m in receivables that were due within 12 months. So it actually has RM14.9m more liquid assets than total liabilities.

This surplus suggests that Adventa Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Adventa Berhad 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 Adventa Berhad wasn't profitable at an EBIT level, but managed to grow its revenue by 145%, to RM78m. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Even though Adventa Berhad managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping RM44m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. Nonetheless, the revenue growth is clearly impressive and that would make it easier to raise capital if need be. So it's risky, but with some potential. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Adventa Berhad is showing 4 warning signs in our investment analysis , and 2 of those are a bit concerning...

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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