Does Air Canada (TSE:AC) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Air Canada (TSE:AC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Air Canada Carry?

As you can see below, Air Canada had CA$10.2b of debt at December 2024, down from CA$11.3b a year prior. However, it also had CA$6.98b in cash, and so its net debt is CA$3.26b.

A Look At Air Canada's Liabilities

We can see from the most recent balance sheet that Air Canada had liabilities of CA$11.4b falling due within a year, and liabilities of CA$17.4b due beyond that. Offsetting these obligations, it had cash of CA$6.98b as well as receivables valued at CA$1.09b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$20.7b.

This deficit casts a shadow over the CA$4.63b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Air Canada would probably need a major re-capitalization if its creditors were to demand repayment.

View our latest analysis for Air Canada

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Air Canada's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Air Canada's EBIT fell a jaw-dropping 43% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Air Canada 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Air Canada actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Air Canada's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Air Canada has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. For example, we've discovered 2 warning signs for Air Canada (1 is significant!) that you should be aware of before investing here.

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.

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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.