These 4 Measures Indicate That AVIC Heavy Machinery (SHSE:600765) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that AVIC Heavy Machinery Co., Ltd. (SHSE:600765) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for AVIC Heavy Machinery

What Is AVIC Heavy Machinery's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 AVIC Heavy Machinery had CN¥3.26b of debt, an increase on CN¥2.74b, over one year. However, it does have CN¥4.80b in cash offsetting this, leading to net cash of CN¥1.54b.

How Healthy Is AVIC Heavy Machinery's Balance Sheet?

We can see from the most recent balance sheet that AVIC Heavy Machinery had liabilities of CN¥10.6b falling due within a year, and liabilities of CN¥2.54b due beyond that. On the other hand, it had cash of CN¥4.80b and CN¥9.76b worth of receivables due within a year. So it can boast CN¥1.46b more liquid assets than total liabilities.

This surplus suggests that AVIC Heavy Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AVIC Heavy Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that AVIC Heavy Machinery has increased its EBIT by 4.7% over twelve months, which should ease any concerns about debt repayment. 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 AVIC Heavy Machinery 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. AVIC Heavy Machinery 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. Over the last three years, AVIC Heavy Machinery recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case AVIC Heavy Machinery has CN¥1.54b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 4.7% in the last twelve months. So we don't have any problem with AVIC Heavy Machinery's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with AVIC Heavy Machinery , and understanding them should be part of your investment process.

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. 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.

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