These 4 Measures Indicate That Qantas Airways (ASX:QAN) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Qantas Airways Limited (ASX:QAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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, 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.

See our latest analysis for Qantas Airways

How Much Debt Does Qantas Airways Carry?

You can click the graphic below for the historical numbers, but it shows that Qantas Airways had AU$5.17b of debt in June 2023, down from AU$5.96b, one year before. On the flip side, it has AU$3.25b in cash leading to net debt of about AU$1.92b.

How Healthy Is Qantas Airways' Balance Sheet?

We can see from the most recent balance sheet that Qantas Airways had liabilities of AU$12.1b falling due within a year, and liabilities of AU$8.25b due beyond that. Offsetting these obligations, it had cash of AU$3.25b as well as receivables valued at AU$1.06b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$16.0b.

This deficit casts a shadow over the AU$8.72b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Qantas Airways would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Qantas Airways's net debt is only 0.47 times its EBITDA. And its EBIT easily covers its interest expense, being 16.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Although Qantas Airways made a loss at the EBIT level, last year, it was also good to see that it generated AU$2.7b in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Qantas Airways can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Qantas Airways generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

While Qantas Airways's level of total liabilities has us nervous. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. We think that Qantas Airways's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Qantas Airways is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.