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.' 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 China Southern Airlines Company Limited (HKG:1055) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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.
Check out our latest analysis for China Southern Airlines
What Is China Southern Airlines's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2022 China Southern Airlines had debt of CN¥122.6b, up from CN¥107.6b in one year. However, it does have CN¥20.0b in cash offsetting this, leading to net debt of about CN¥102.5b.
How Strong Is China Southern Airlines' Balance Sheet?
According to the last reported balance sheet, China Southern Airlines had liabilities of CN¥117.9b due within 12 months, and liabilities of CN¥122.2b due beyond 12 months. Offsetting these obligations, it had cash of CN¥20.0b as well as receivables valued at CN¥4.61b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥215.5b.
This deficit casts a shadow over the CN¥97.1b 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Southern Airlines can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, China Southern Airlines reported revenue of CN¥102b, which is a gain of 9.9%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Importantly, China Southern Airlines had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥9.9b 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 had negative free cash flow of CN¥2.9b over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Southern Airlines you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
About SEHK:1055
China Southern Airlines
Offers airline transportation services in the People’s Republic of China, Hong Kong, Macau, Taiwan, and internationally.
Undervalued with moderate growth potential.