Stock Analysis

China Southern Airlines (HKG:1055) Has Debt But No Earnings; Should You Worry?

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SEHK:1055
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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, China Southern Airlines Company Limited (HKG:1055) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is China Southern Airlines's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 China Southern Airlines had debt of CN¥78.2b, up from CN¥51.2b in one year. However, it does have CN¥25.8b in cash offsetting this, leading to net debt of about CN¥52.4b.

debt-equity-history-analysis
SEHK:1055 Debt to Equity History April 11th 2021

How Healthy Is China Southern Airlines' Balance Sheet?

The latest balance sheet data shows that China Southern Airlines had liabilities of CN¥95.7b due within a year, and liabilities of CN¥145.6b falling due after that. Offsetting these obligations, it had cash of CN¥25.8b as well as receivables valued at CN¥4.34b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥211.1b.

This deficit casts a shadow over the CN¥95.7b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Southern Airlines would probably need a major re-capitalization if its creditors were to demand repayment. 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 China Southern Airlines'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.

In the last year China Southern Airlines had a loss before interest and tax, and actually shrunk its revenue by 40%, to CN¥93b. To be frank that doesn't bode well.

Caveat Emptor

Not only did China Southern Airlines's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥8.9b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥2.0b in negative free cash flow over the last year. That means it's on the risky side of things. 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. Case in point: We've spotted 3 warning signs for China Southern Airlines you should be aware of, and 1 of them is potentially serious.

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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