We Think AECC Aviation PowerLtd (SHSE:600893) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, AECC Aviation Power Co.,Ltd (SHSE:600893) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for AECC Aviation PowerLtd

What Is AECC Aviation PowerLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 AECC Aviation PowerLtd had debt of CN¥8.15b, up from CN¥3.10b in one year. However, because it has a cash reserve of CN¥3.29b, its net debt is less, at about CN¥4.86b.

How Strong Is AECC Aviation PowerLtd's Balance Sheet?

We can see from the most recent balance sheet that AECC Aviation PowerLtd had liabilities of CN¥60.1b falling due within a year, and liabilities of -CN¥3.20b due beyond that. Offsetting these obligations, it had cash of CN¥3.29b as well as receivables valued at CN¥26.5b due within 12 months. So its liabilities total CN¥27.2b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since AECC Aviation PowerLtd has a huge market capitalization of CN¥97.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

AECC Aviation PowerLtd has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 21.7 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that AECC Aviation PowerLtd grew its EBIT by 108% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 AECC Aviation PowerLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, AECC Aviation PowerLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen AECC Aviation PowerLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that AECC Aviation PowerLtd is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AECC Aviation PowerLtd you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com