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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies AoFrio Limited (NZSE:AOF) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for AoFrio
What Is AoFrio's Net Debt?
As you can see below, at the end of June 2023, AoFrio had NZ$8.80m of debt, up from NZ$1.31m a year ago. Click the image for more detail. On the flip side, it has NZ$2.52m in cash leading to net debt of about NZ$6.29m.
A Look At AoFrio's Liabilities
The latest balance sheet data shows that AoFrio had liabilities of NZ$27.7m due within a year, and liabilities of NZ$14.1m falling due after that. On the other hand, it had cash of NZ$2.52m and NZ$19.3m worth of receivables due within a year. So its liabilities total NZ$20.0m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of NZ$25.0m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since AoFrio 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 AoFrio wasn't profitable at an EBIT level, but managed to grow its revenue by 11%, to NZ$73m. We usually like to see faster growth from unprofitable companies, but each to their own.
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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NZ$9.6m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for AoFrio (2 are concerning!) that you should be aware of before investing here.
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.
