Dassault Aviation (EPA:AM) Takes On Some Risk With Its Use Of Debt

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.' 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 Dassault Aviation SA (EPA:AM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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 Dassault Aviation

What Is Dassault Aviation's Debt?

The image below, which you can click on for greater detail, shows that Dassault Aviation had debt of €105.8m at the end of June 2021, a reduction from €147.2m over a year. But on the other hand it also has €3.61b in cash, leading to a €3.50b net cash position.

How Healthy Is Dassault Aviation's Balance Sheet?

According to the last reported balance sheet, Dassault Aviation had liabilities of €8.99b due within 12 months, and liabilities of €210.6m due beyond 12 months. Offsetting these obligations, it had cash of €3.61b as well as receivables valued at €1.33b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €4.27b.

This deficit isn't so bad because Dassault Aviation is worth €8.06b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Dassault Aviation boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Dassault Aviation if management cannot prevent a repeat of the 30% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dassault Aviation can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dassault Aviation may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Dassault Aviation 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.

Summing up

Although Dassault Aviation's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €3.50b. Despite the cash, we do find Dassault Aviation's EBIT growth rate concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Dassault Aviation , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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