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. Importantly, Air China Limited (HKG:753) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is Air China's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Air China had CN¥68.7b of debt, an increase on CN¥38.4b, over one year. On the flip side, it has CN¥6.58b in cash leading to net debt of about CN¥62.1b.
How Healthy Is Air China's Balance Sheet?
The latest balance sheet data shows that Air China had liabilities of CN¥80.4b due within a year, and liabilities of CN¥119.9b falling due after that. On the other hand, it had cash of CN¥6.58b and CN¥6.44b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥187.2b.
This deficit casts a shadow over the CN¥114.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Air China 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 ultimately the future profitability of the business will decide if Air China 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.
In the last year Air China had a loss before interest and tax, and actually shrunk its revenue by 49%, to CN¥70b. That makes us nervous, to say the least.
Not only did Air China's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥11b. 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¥11b over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Air China has 1 warning sign we think you should be aware of.
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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Air China Limited, together with its subsidiaries, provides air passenger, air cargo, and airline-related services in Mainland China, Hong Kong, Macau, Taiwan, Europe, North America, Japan, Korea, the Asia Pacific, and internationally.
Exceptional growth potential and good value.