Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Air China Limited (HKG:753) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Air China
How Much Debt Does Air China Carry?
The image below, which you can click on for greater detail, shows that at September 2021 Air China had debt of CN¥92.0b, up from CN¥81.7b in one year. However, because it has a cash reserve of CN¥9.48b, its net debt is less, at about CN¥82.5b.
How Healthy Is Air China's Balance Sheet?
The latest balance sheet data shows that Air China had liabilities of CN¥81.9b due within a year, and liabilities of CN¥132.4b falling due after that. On the other hand, it had cash of CN¥9.48b and CN¥5.88b worth of receivables due within a year. 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¥104.2b 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, 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're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Air China made a loss at the EBIT level, and saw its revenue drop to CN¥79b, which is a fall of 3.7%. We would much prefer see growth.
Caveat Emptor
Over the last twelve months Air China produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥13b. 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. It's fair to say the loss of CN¥15b didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. To that end, you should be aware of the 1 warning sign we've spotted with Air China .
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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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.
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About SEHK:753
Air China
Provides air passenger, air cargo, and airline-related services in Mainland China, Hong Kong, Macau, Taiwan, and internationally.
Undervalued with reasonable growth potential.
