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Is Avon Rubber (LON:AVON) A Risky Investment?

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.' 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. As with many other companies Avon Rubber p.l.c. (LON:AVON) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Avon Rubber

How Much Debt Does Avon Rubber Carry?

As you can see below, at the end of September 2020, Avon Rubber had UK£31.0m of debt, up from UK£100.0k a year ago. Click the image for more detail. But it also has UK£147.0m in cash to offset that, meaning it has UK£116.0m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Avon Rubber's Balance Sheet?

According to the last reported balance sheet, Avon Rubber had liabilities of UK£79.6m due within 12 months, and liabilities of UK£97.1m due beyond 12 months. Offsetting this, it had UK£147.0m in cash and UK£36.1m in receivables that were due within 12 months. So it can boast UK£6.40m more liquid assets than total liabilities.

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This state of affairs indicates that Avon Rubber's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the UK£1.29b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Avon Rubber boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Avon Rubber's load is not too heavy, because its EBIT was down 43% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Avon Rubber's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Avon Rubber may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Avon Rubber recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Avon Rubber has net cash of UK£116.0m, as well as more liquid assets than liabilities. So we are not troubled with Avon Rubber's debt use. 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. Case in point: We've spotted 2 warning signs for Avon Rubber you should be aware of, and 1 of them is significant.

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.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.