We Think AviChina Industry & Technology (HKG:2357) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, AviChina Industry & Technology Company Limited (HKG:2357) does carry 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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 2357 is potentially undervalued!

What Is AviChina Industry & Technology's Debt?

As you can see below, at the end of June 2022, AviChina Industry & Technology had CN¥12.4b of debt, up from CN¥8.93b a year ago. Click the image for more detail. However, it does have CN¥17.3b in cash offsetting this, leading to net cash of CN¥4.98b.

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

Zooming in on the latest balance sheet data, we can see that AviChina Industry & Technology had liabilities of CN¥69.7b due within 12 months and liabilities of CN¥8.54b due beyond that. On the other hand, it had cash of CN¥17.3b and CN¥43.2b worth of receivables due within a year. So its liabilities total CN¥17.7b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥20.5b. 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!

AviChina Industry & Technology's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 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. 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 saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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¥4.98b. So while AviChina Industry & Technology does not have a great balance sheet, it's certainly not too bad. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check AviChina Industry & Technology's dividend history, without delay!

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. 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.