Does Alliance Aviation Services (ASX:AQZ) Have A Healthy Balance Sheet?

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 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 Alliance Aviation Services Limited (ASX:AQZ) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alliance Aviation Services

What Is Alliance Aviation Services's Net Debt?

As you can see below, Alliance Aviation Services had AU$54.4m of debt at June 2020, down from AU$60.1m a year prior. But it also has AU$98.8m in cash to offset that, meaning it has AU$44.4m net cash.

How Healthy Is Alliance Aviation Services's Balance Sheet?

We can see from the most recent balance sheet that Alliance Aviation Services had liabilities of AU$70.8m falling due within a year, and liabilities of AU$83.0m due beyond that. Offsetting this, it had AU$98.8m in cash and AU$51.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.6m.

This state of affairs indicates that Alliance Aviation Services'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 AU$566.8m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Alliance Aviation Services also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Alliance Aviation Services has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. 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 Alliance Aviation Services'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Alliance Aviation Services 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. In the last three years, Alliance Aviation Services's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Alliance Aviation Services's liabilities, but we can be reassured by the fact it has has net cash of AU$44.4m. And we liked the look of last year's 28% year-on-year EBIT growth. So we don't think Alliance Aviation Services's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Alliance Aviation Services you should be aware of.

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. 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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