Is AviChina Industry & Technology (HKG:2357) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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?

You can click the graphic below for the historical numbers, but it shows that AviChina Industry & Technology had CN¥10.8b of debt in December 2021, down from CN¥12.0b, one year before. But on the other hand it also has CN¥25.0b in cash, leading to a CN¥14.2b net cash position.

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¥69.6b falling due within a year, and liabilities of CN¥9.54b due beyond that. Offsetting these obligations, it had cash of CN¥25.0b as well as receivables valued at CN¥36.6b due within 12 months. So its liabilities total CN¥17.5b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥26.2b, so it does suggest shareholders should keep an eye on AviChina Industry & Technology's use of debt. 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 32%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 reported free cash flow worth 8.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While AviChina Industry & Technology does have more liabilities than liquid assets, it also has net cash of CN¥14.2b. And it impressed us with its EBIT growth of 32% over the last year. So we are not troubled with AviChina Industry & Technology's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of AviChina Industry & Technology's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.