Does Hainan Meilan International Airport (HKG:357) Have A Healthy Balance Sheet?

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 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. We note that Hainan Meilan International Airport Company Limited (HKG:357) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hainan Meilan International Airport

What Is Hainan Meilan International Airport's Debt?

You can click the graphic below for the historical numbers, but it shows that Hainan Meilan International Airport had CN¥309.7m of debt in December 2020, down from CN¥2.87b, one year before. On the flip side, it has CN¥292.2m in cash leading to net debt of about CN¥17.6m.

How Healthy Is Hainan Meilan International Airport's Balance Sheet?

We can see from the most recent balance sheet that Hainan Meilan International Airport had liabilities of CN¥6.91b falling due within a year, and liabilities of CN¥358.4m due beyond that. On the other hand, it had cash of CN¥292.2m and CN¥361.5m worth of receivables due within a year. So it has liabilities totalling CN¥6.61b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Hainan Meilan International Airport is worth CN¥13.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. But either way, Hainan Meilan International Airport has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With debt at a measly 0.039 times EBITDA and EBIT covering interest a whopping 20.6 times, it's clear that Hainan Meilan International Airport is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. The modesty of its debt load may become crucial for Hainan Meilan International Airport if management cannot prevent a repeat of the 60% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hainan Meilan International Airport can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hainan Meilan International Airport burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Hainan Meilan International Airport's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Infrastructure industry companies like Hainan Meilan International Airport commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Hainan Meilan International Airport stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. We've identified 1 warning sign with Hainan Meilan International Airport , and understanding them should be part of your investment process.

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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