China Aerospace International Holdings (HKG:31) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies China Aerospace International Holdings Limited (HKG:31) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Aerospace International Holdings

How Much Debt Does China Aerospace International Holdings Carry?

As you can see below, at the end of June 2021, China Aerospace International Holdings had HK$1.55b of debt, up from HK$1.42b a year ago. Click the image for more detail. However, it does have HK$1.90b in cash offsetting this, leading to net cash of HK$352.9m.

How Strong Is China Aerospace International Holdings' Balance Sheet?

The latest balance sheet data shows that China Aerospace International Holdings had liabilities of HK$1.83b due within a year, and liabilities of HK$4.22b falling due after that. Offsetting these obligations, it had cash of HK$1.90b as well as receivables valued at HK$1.34b due within 12 months. So it has liabilities totalling HK$2.81b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$1.85b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Aerospace International Holdings would probably need a major re-capitalization if its creditors were to demand repayment. China Aerospace International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

And we also note warmly that China Aerospace International Holdings grew its EBIT by 16% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Aerospace International Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Aerospace International Holdings 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. During the last three years, China Aerospace International Holdings generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While China Aerospace International Holdings does have more liabilities than liquid assets, it also has net cash of HK$352.9m. And it impressed us with free cash flow of HK$237m, being 89% of its EBIT. So we don't have any problem with China Aerospace International Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for China Aerospace International Holdings (1 makes us a bit uncomfortable) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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