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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Southern Airlines

What Is China Southern Airlines's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 China Southern Airlines had debt of CN¥105.6b, up from CN¥85.0b in one year. However, it does have CN¥22.3b in cash offsetting this, leading to net debt of about CN¥83.3b.

A Look At China Southern Airlines' Liabilities

Zooming in on the latest balance sheet data, we can see that China Southern Airlines had liabilities of CN¥101.8b due within 12 months and liabilities of CN¥130.9b due beyond that. Offsetting these obligations, it had cash of CN¥22.3b as well as receivables valued at CN¥5.22b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥205.1b.

This deficit casts a shadow over the CN¥97.3b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, China Southern Airlines would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. 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¥106b, which is a gain of 2.6%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months China Southern Airlines produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥5.5b. Considering that alongside the liabilities mentioned above make us nervous 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¥2.6b over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with China Southern Airlines (including 1 which is concerning) .

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.