Jiangsu Maixinlin Aviation Science and Technology (SHSE:688685) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Jiangsu Maixinlin Aviation Science and Technology Corp. (SHSE:688685) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Jiangsu Maixinlin Aviation Science and Technology

What Is Jiangsu Maixinlin Aviation Science and Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Jiangsu Maixinlin Aviation Science and Technology had CN¥749.8m of debt, an increase on CN¥13.0m, over one year. However, because it has a cash reserve of CN¥108.5m, its net debt is less, at about CN¥641.3m.

How Healthy Is Jiangsu Maixinlin Aviation Science and Technology's Balance Sheet?

According to the last reported balance sheet, Jiangsu Maixinlin Aviation Science and Technology had liabilities of CN¥1.08b due within 12 months, and liabilities of CN¥168.0m due beyond 12 months. On the other hand, it had cash of CN¥108.5m and CN¥303.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥833.5m.

Of course, Jiangsu Maixinlin Aviation Science and Technology has a market capitalization of CN¥9.12b, 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.

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.

With a net debt to EBITDA ratio of 8.6, it's fair to say Jiangsu Maixinlin Aviation Science and Technology does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.4 times, suggesting it can responsibly service its obligations. The good news is that Jiangsu Maixinlin Aviation Science and Technology grew its EBIT a smooth 96% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Maixinlin Aviation Science and Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Jiangsu Maixinlin Aviation Science and Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Jiangsu Maixinlin Aviation Science and Technology's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. We think that Jiangsu Maixinlin Aviation Science and Technology's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For instance, we've identified 4 warning signs for Jiangsu Maixinlin Aviation Science and Technology (3 are concerning) 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.