Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that AoFrio Limited (NZSE:AOF) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. 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, 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.
Check out our latest analysis for AoFrio
What Is AoFrio's Debt?
The image below, which you can click on for greater detail, shows that AoFrio had debt of NZ$4.46m at the end of June 2024, a reduction from NZ$8.80m over a year. However, because it has a cash reserve of NZ$1.95m, its net debt is less, at about NZ$2.51m.
A Look At AoFrio's Liabilities
Zooming in on the latest balance sheet data, we can see that AoFrio had liabilities of NZ$31.1m due within 12 months and liabilities of NZ$16.2m due beyond that. On the other hand, it had cash of NZ$1.95m and NZ$20.9m worth of receivables due within a year. So its liabilities total NZ$24.5m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because AoFrio is worth NZ$49.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 AoFrio will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year AoFrio wasn't profitable at an EBIT level, but managed to grow its revenue by 3.1%, to NZ$75m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Over the last twelve months AoFrio produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at NZ$506k. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of NZ$1.9m. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for AoFrio you should know about.
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.
About NZSE:AOF
Flawless balance sheet and good value.
