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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Aega ASA (OB:AEGA) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Aega's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Aega had €5.00m of debt, an increase on €3.04m, over one year. However, it does have €1.93m in cash offsetting this, leading to net debt of about €3.07m.
How Strong Is Aega's Balance Sheet?
We can see from the most recent balance sheet that Aega had liabilities of €1.64m falling due within a year, and liabilities of €6.29m due beyond that. Offsetting these obligations, it had cash of €1.93m as well as receivables valued at €1.60m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €4.40m.
This deficit isn't so bad because Aega is worth €11.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Aega's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
While it hasn't made a profit, at least Aega booked its first revenue as a publicly listed company, in the last twelve months.
Importantly, Aega had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at €942k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through €391k of cash over the last year. So suffice it to say we do consider the stock to be 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. Be aware that Aega is showing 3 warning signs in our investment analysis , and 1 of those is significant...
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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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.
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