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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that AIA Engineering Limited (NSE:AIAENG) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for AIA Engineering

How Much Debt Does AIA Engineering Carry?

As you can see below, AIA Engineering had ₹1.20b of debt at September 2024, down from ₹4.79b a year prior. But on the other hand it also has ₹33.1b in cash, leading to a ₹31.9b net cash position.

A Look At AIA Engineering's Liabilities

According to the last reported balance sheet, AIA Engineering had liabilities of ₹4.66b due within 12 months, and liabilities of ₹875.9m due beyond 12 months. On the other hand, it had cash of ₹33.1b and ₹7.61b worth of receivables due within a year. So it can boast ₹35.2b more liquid assets than total liabilities.

This surplus suggests that AIA Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AIA Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that AIA Engineering has seen its EBIT plunge 18% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Over the most recent three years, AIA Engineering recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that AIA Engineering has net cash of ₹31.9b, as well as more liquid assets than liabilities. So we don't have any problem with AIA Engineering's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AIA Engineering you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.