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 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. As with many other companies AoFrio Limited (NZSE:AOF) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
View our latest analysis for AoFrio
How Much Debt Does AoFrio Carry?
The image below, which you can click on for greater detail, shows that at June 2023 AoFrio had debt of NZ$8.80m, up from NZ$1.31m in one year. On the flip side, it has NZ$2.52m in cash leading to net debt of about NZ$6.29m.
How Healthy Is AoFrio's Balance Sheet?
We can see from the most recent balance sheet that AoFrio had liabilities of NZ$27.7m falling due within a year, and liabilities of NZ$14.1m due beyond that. Offsetting these obligations, it had cash of NZ$2.52m as well as receivables valued at NZ$19.3m due within 12 months. So its liabilities total NZ$20.0m more than the combination of its cash and short-term receivables.
AoFrio has a market capitalization of NZ$33.7m, so it could very likely raise cash to ameliorate 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. When analysing debt levels, the balance sheet is the obvious place to start. 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.
Over 12 months, AoFrio reported revenue of NZ$73m, which is a gain of 11%, although it did not report any earnings before interest and tax. 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$2.1m. 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. Another cause for caution is that is bled NZ$9.6m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. For example AoFrio has 3 warning signs (and 1 which can't be ignored) we think you should know about.
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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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.
