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

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.' 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 more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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 Debt?

You can click the graphic below for the historical numbers, but it shows that AviChina Industry & Technology had CN¥7.25b of debt in June 2021, down from CN¥12.7b, one year before. But it also has CN¥21.0b in cash to offset that, meaning it has CN¥13.8b net cash.

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

We can see from the most recent balance sheet that AviChina Industry & Technology had liabilities of CN¥65.2b falling due within a year, and liabilities of CN¥8.62b due beyond that. Offsetting this, it had CN¥21.0b in cash and CN¥33.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥19.4b.

This is a mountain of leverage relative to its market capitalization of CN¥32.2b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, AviChina Industry & Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that AviChina Industry & Technology has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AviChina Industry & Technology's ability to maintain a healthy balance sheet going forward. 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. 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. During the last three years, AviChina Industry & Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although AviChina Industry & Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥13.8b. And it impressed us with its EBIT growth of 48% over the last year. So we don't have any problem with AviChina Industry & Technology's use of debt. 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.

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.

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