Here's Why Guizhou Aviation Technical Development (SHSE:688239) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Guizhou Aviation Technical Development Co., Ltd (SHSE:688239) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its 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, Guizhou Aviation Technical Development had CN¥768.3m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥256.9m, its net debt is less, at about CN¥511.4m.

A Look At Guizhou Aviation Technical Development's Liabilities

According to the last reported balance sheet, Guizhou Aviation Technical Development had liabilities of CN¥1.18b due within 12 months, and liabilities of CN¥507.6m due beyond 12 months. Offsetting this, it had CN¥256.9m in cash and CN¥1.25b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥181.3m.

Given Guizhou Aviation Technical Development has a market capitalization of CN¥5.59b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 1.8, Guizhou Aviation Technical Development uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.3 times its interest expenses harmonizes with that theme. Importantly Guizhou Aviation Technical Development's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guizhou Aviation Technical Development's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Guizhou Aviation Technical Development burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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 cast it in a significantly better light. In particular, its interest cover was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Guizhou Aviation Technical Development is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 1 warning sign for Guizhou Aviation Technical Development you should be aware of.

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.

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