Is Guangzhou Hangxin Aviation Technology (SZSE:300424) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Guangzhou Hangxin Aviation Technology Co., Ltd. (SZSE:300424) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Guangzhou Hangxin Aviation Technology

What Is Guangzhou Hangxin Aviation Technology's Debt?

The chart below, which you can click on for greater detail, shows that Guangzhou Hangxin Aviation Technology had CN¥893.8m in debt in September 2024; about the same as the year before. However, because it has a cash reserve of CN¥217.7m, its net debt is less, at about CN¥676.0m.

A Look At Guangzhou Hangxin Aviation Technology's Liabilities

According to the last reported balance sheet, Guangzhou Hangxin Aviation Technology had liabilities of CN¥1.02b due within 12 months, and liabilities of CN¥574.2m due beyond 12 months. On the other hand, it had cash of CN¥217.7m and CN¥780.1m worth of receivables due within a year. So it has liabilities totalling CN¥592.1m more than its cash and near-term receivables, combined.

Of course, Guangzhou Hangxin Aviation Technology has a market capitalization of CN¥3.99b, 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.5 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in Guangzhou Hangxin Aviation Technology like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that Guangzhou Hangxin Aviation Technology grew its EBIT a smooth 47% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Guangzhou Hangxin Aviation Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Looking at the most recent three years, Guangzhou Hangxin Aviation Technology recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Guangzhou Hangxin Aviation Technology's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at managing its debt, based on its EBITDA, as wet socks are at keeping your feet warm. It's also worth noting that Guangzhou Hangxin Aviation Technology is in the Infrastructure industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Guangzhou Hangxin Aviation Technology is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 2 warning signs for Guangzhou Hangxin Aviation Technology you should be aware of, and 1 of them is significant.

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.