Guizhou Aviation Technical Development (SHSE:688239) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Guizhou Aviation Technical Development Co., Ltd (SHSE:688239) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Guizhou Aviation Technical Development

What Is Guizhou Aviation Technical Development's Debt?

As you can see below, at the end of September 2023, Guizhou Aviation Technical Development had CN¥723.5m of debt, up from CN¥687.7m a year ago. Click the image for more detail. However, it also had CN¥213.6m in cash, and so its net debt is CN¥509.8m.

A Look At Guizhou Aviation Technical Development's Liabilities

The latest balance sheet data shows that Guizhou Aviation Technical Development had liabilities of CN¥1.37b due within a year, and liabilities of CN¥473.2m falling due after that. Offsetting these obligations, it had cash of CN¥213.6m as well as receivables valued at CN¥1.22b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥414.8m.

Of course, Guizhou Aviation Technical Development has a market capitalization of CN¥5.78b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Guizhou Aviation Technical Development's net debt of 1.7 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.6 times interest expense) certainly does not do anything to dispel this impression. Also good is that Guizhou Aviation Technical Development grew its EBIT at 16% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guizhou Aviation Technical Development 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Guizhou Aviation Technical Development 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

Guizhou Aviation Technical Development's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Guizhou Aviation Technical Development's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. We've identified 2 warning signs with Guizhou Aviation Technical Development , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.