Is AIREA (LON:AIEA) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 AIREA plc (LON:AIEA) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for AIREA

What Is AIREA's Net Debt?

As you can see below, at the end of June 2021, AIREA had UK£4.27m of debt, up from UK£3.90m a year ago. Click the image for more detail. However, its balance sheet shows it holds UK£6.23m in cash, so it actually has UK£1.96m net cash.

How Strong Is AIREA's Balance Sheet?

The latest balance sheet data shows that AIREA had liabilities of UK£5.32m due within a year, and liabilities of UK£4.29m falling due after that. Offsetting these obligations, it had cash of UK£6.23m as well as receivables valued at UK£2.09m due within 12 months. So it has liabilities totalling UK£1.29m more than its cash and near-term receivables, combined.

Of course, AIREA has a market capitalization of UK£11.8m, 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. While it does have liabilities worth noting, AIREA also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, AIREA's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since AIREA will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While AIREA has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, AIREA generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although AIREA's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£1.96m. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in -UK£235k. So we are not troubled with AIREA's debt use. 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. We've identified 2 warning signs with AIREA (at least 1 which is a bit concerning) , 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. 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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