Health Check: How Prudently Does Air Canada (TSE:AC) Use Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Air Canada (TSE:AC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Air Canada

What Is Air Canada's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Air Canada had debt of CA$13.3b, up from CA$9.39b in one year. However, it also had CA$8.80b in cash, and so its net debt is CA$4.54b.

How Strong Is Air Canada's Balance Sheet?

The latest balance sheet data shows that Air Canada had liabilities of CA$6.92b due within a year, and liabilities of CA$23.7b falling due after that. On the other hand, it had cash of CA$8.80b and CA$691.0m worth of receivables due within a year. So it has liabilities totalling CA$21.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CA$8.42b 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Air Canada can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Air Canada wasn't profitable at an EBIT level, but managed to grow its revenue by 9.7%, to CA$6.4b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Air Canada produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CA$3.1b at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized CA$2.6b in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Air Canada has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.