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. We note that Air China Limited (HKG:753) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Air China Carry?
As you can see below, at the end of September 2021, Air China had CN¥92.0b of debt, up from CN¥81.7b a year ago. Click the image for more detail. However, it also had CN¥9.48b in cash, and so its net debt is CN¥82.5b.
How Healthy Is Air China's Balance Sheet?
We can see from the most recent balance sheet that Air China had liabilities of CN¥81.9b falling due within a year, and liabilities of CN¥132.4b due beyond that. Offsetting this, it had CN¥9.48b in cash and CN¥5.88b in receivables that were due within 12 months. So it has liabilities totalling CN¥198.9b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥126.7b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Air China 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 it is future earnings, more than anything, that will determine Air China'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.
In the last year Air China had a loss before interest and tax, and actually shrunk its revenue by 3.7%, to CN¥79b. That's not what we would hope to see.
Over the last twelve months Air China produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥13b. 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. It's fair to say the loss of CN¥15b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. We've identified 1 warning sign with Air China , 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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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.
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.