Stock Analysis

Is China Southern Airlines (HKG:1055) Using Too Much Debt?

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SEHK:1055
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Southern Airlines Company Limited (HKG:1055) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 China Southern Airlines

What Is China Southern Airlines's Net Debt?

As you can see below, China Southern Airlines had CN¥63.3b of debt at September 2020, down from CN¥68.3b a year prior. However, because it has a cash reserve of CN¥17.2b, its net debt is less, at about CN¥46.0b.

debt-equity-history-analysis
SEHK:1055 Debt to Equity History December 27th 2020

A Look At China Southern Airlines's Liabilities

We can see from the most recent balance sheet that China Southern Airlines had liabilities of CN¥89.3b falling due within a year, and liabilities of CN¥142.1b due beyond that. Offsetting these obligations, it had cash of CN¥17.2b as well as receivables valued at CN¥4.68b due within 12 months. So its liabilities total CN¥209.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥81.7b 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 definitely think shareholders need to watch this one closely. After all, China Southern Airlines would likely require a major re-capitalisation if it had to pay its creditors today. 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 China Southern Airlines'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.

Over 12 months, China Southern Airlines made a loss at the EBIT level, and saw its revenue drop to CN¥103b, which is a fall of 32%. 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). Its EBIT loss was a whopping CN¥8.4b. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost CN¥8.9b in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with China Southern Airlines .

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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