These 4 Measures Indicate That AIREA (LON:AIEA) Is Using Debt Reasonably Well

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. As with many other companies AIREA plc (LON:AIEA) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for AIREA

What Is AIREA's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 AIREA had UK£3.71m of debt, an increase on UK£1.29m, over one year. However, it does have UK£6.56m in cash offsetting this, leading to net cash of UK£2.84m.

How Healthy Is AIREA's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AIREA had liabilities of UK£4.67m due within 12 months and liabilities of UK£5.23m due beyond that. On the other hand, it had cash of UK£6.56m and UK£1.71m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.63m.

Of course, AIREA has a market capitalization of UK£13.3m, 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.

It is just as well that AIREA's load is not too heavy, because its EBIT was down 81% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is AIREA's earnings that will influence how the balance sheet holds up in the future. 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. AIREA 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. Over the last three years, AIREA actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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£2.84m. And it impressed us with free cash flow of UK£1.6m, being 107% of its EBIT. So we are not troubled with AIREA's debt use. 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 3 warning signs with AIREA , and understanding them should be part of your investment process.

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. 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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