Is Air Canada (TSE:AC) Using Debt In A Risky Way?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Air Canada (TSE:AC) does carry debt. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
See our latest analysis for Air Canada
How Much Debt Does Air Canada Carry?
As you can see below, at the end of September 2020, Air Canada had CA$9.80b of debt, up from CA$5.99b a year ago. Click the image for more detail. However, because it has a cash reserve of CA$7.78b, its net debt is less, at about CA$2.03b.
A Look At Air Canada's Liabilities
The latest balance sheet data shows that Air Canada had liabilities of CA$7.24b due within a year, and liabilities of CA$19.6b falling due after that. Offsetting this, it had CA$7.78b in cash and CA$518.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$18.6b.
The deficiency here weighs heavily on the CA$6.16b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Air Canada would likely require a major re-capitalisation if it had to pay its creditors today. 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.
Over 12 months, Air Canada made a loss at the EBIT level, and saw its revenue drop to CA$9.4b, which is a fall of 50%. To be frank that doesn't bode well.
While Air Canada's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$2.6b at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized CA$2.0b 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. 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. To that end, you should learn about the 3 warning signs we've spotted with Air Canada (including 1 which is 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.
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Air Canada provides domestic, U.S. transborder, and international airline services.
Undervalued with high growth potential.