AviChina Industry & Technology (HKG:2357) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies AviChina Industry & Technology Company Limited (HKG:2357) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 AviChina Industry & Technology

What Is AviChina Industry & Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 AviChina Industry & Technology had debt of CN¥11.7b, up from CN¥10.8b in one year. However, its balance sheet shows it holds CN¥26.7b in cash, so it actually has CN¥15.1b net cash.

How Healthy Is AviChina Industry & Technology's Balance Sheet?

The latest balance sheet data shows that AviChina Industry & Technology had liabilities of CN¥61.9b due within a year, and liabilities of CN¥8.44b falling due after that. On the other hand, it had cash of CN¥26.7b and CN¥29.7b worth of receivables due within a year. So its liabilities total CN¥13.9b more than the combination of its cash and short-term receivables.

AviChina Industry & Technology has a market capitalization of CN¥34.3b, so it could very likely raise cash to ameliorate 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, AviChina Industry & Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that AviChina Industry & Technology grew its EBIT by 16% last year, making its debt load easier to handle. 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 AviChina Industry & Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. AviChina Industry & Technology 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, AviChina Industry & Technology recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While AviChina Industry & Technology does have more liabilities than liquid assets, it also has net cash of CN¥15.1b. And it impressed us with its EBIT growth of 16% over the last year. So we are not troubled with AviChina Industry & Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for AviChina Industry & Technology that you should be aware of before investing here.

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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