Is AIA Engineering (NSE:AIAENG) A Risky Investment?

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.' 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 note that AIA Engineering Limited (NSE:AIAENG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for AIA Engineering

What Is AIA Engineering's Net Debt?

As you can see below, at the end of September 2022, AIA Engineering had ₹4.67b of debt, up from ₹2.45b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹21.4b in cash, so it actually has ₹16.8b net cash.

How Healthy Is AIA Engineering's Balance Sheet?

We can see from the most recent balance sheet that AIA Engineering had liabilities of ₹8.83b falling due within a year, and liabilities of ₹431.0m due beyond that. Offsetting these obligations, it had cash of ₹21.4b as well as receivables valued at ₹8.73b due within 12 months. So it can boast ₹20.9b more liquid assets than total liabilities.

This short term liquidity is a sign that AIA Engineering could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that AIA Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that AIA Engineering has boosted its EBIT by 85%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AIA Engineering 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AIA Engineering may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, AIA Engineering recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that AIA Engineering has net cash of ₹16.8b, as well as more liquid assets than liabilities. And we liked the look of last year's 85% year-on-year EBIT growth. So is AIA Engineering's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in AIA Engineering would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.