Here's Why AviChina Industry & Technology (HKG:2357) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, AviChina Industry & Technology Company Limited (HKG:2357) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for AviChina Industry & Technology

What Is AviChina Industry & Technology's Net Debt?

As you can see below, AviChina Industry & Technology had CN¥520.6m of debt at March 2021, down from CN¥12.8b a year prior. But on the other hand it also has CN¥4.07b in cash, leading to a CN¥3.55b net cash position.

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

According to the last reported balance sheet, AviChina Industry & Technology had liabilities of CN¥8.34b due within 12 months, and liabilities of CN¥545.3m due beyond 12 months. On the other hand, it had cash of CN¥4.07b and CN¥9.60b worth of receivables due within a year. So it actually has CN¥4.79b more liquid assets than total liabilities.

This short term liquidity is a sign that AviChina Industry & Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, AviChina Industry & Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, AviChina Industry & Technology grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AviChina Industry & Technology 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. Over the last three years, AviChina Industry & Technology recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case AviChina Industry & Technology has CN¥3.55b in net cash and a decent-looking balance sheet. And we liked the look of last year's 77% year-on-year EBIT growth. So is AviChina Industry & Technology's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that AviChina Industry & Technology is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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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