Air France-KLM (EPA:AF) 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 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 can see that Air France-KLM SA (EPA:AF) does use debt in its business. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

What Is Air France-KLM's Net Debt?

The image below, which you can click on for greater detail, shows that Air France-KLM had debt of €4.80b at the end of December 2024, a reduction from €5.34b over a year. However, it does have €6.01b in cash offsetting this, leading to net cash of €1.22b.

A Look At Air France-KLM's Liabilities

Zooming in on the latest balance sheet data, we can see that Air France-KLM had liabilities of €16.3b due within 12 months and liabilities of €19.1b due beyond that. Offsetting this, it had €6.01b in cash and €2.58b in receivables that were due within 12 months. So it has liabilities totalling €26.8b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €1.99b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Air France-KLM would likely require a major re-capitalisation if it had to pay its creditors today. Given that Air France-KLM has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Check out our latest analysis for Air France-KLM

Sadly, Air France-KLM's EBIT actually dropped 5.6% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Air France-KLM 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Air France-KLM 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. In the last three years, Air France-KLM's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Air France-KLM's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €1.22b. Despite the cash, we do find Air France-KLM's level of total liabilities concerning, so we're not particularly comfortable with the stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Air France-KLM (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.