Controladora Vuela Compañía de Aviación. de (BMV:VOLARA) Takes On Some Risk With Its Use Of Debt

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. Importantly, Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (BMV:VOLARA) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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.

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What Is Controladora Vuela Compañía de Aviación. de's Net Debt?

The image below, which you can click on for greater detail, shows that Controladora Vuela Compañía de Aviación. de had debt of US$241.9m at the end of September 2022, a reduction from US$258.6m over a year. But on the other hand it also has US$750.0m in cash, leading to a US$508.1m net cash position.

A Look At Controladora Vuela Compañía de Aviación. de's Liabilities

The latest balance sheet data shows that Controladora Vuela Compañía de Aviación. de had liabilities of US$1.42b due within a year, and liabilities of US$2.75b falling due after that. Offsetting this, it had US$750.0m in cash and US$203.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.21b.

This deficit casts a shadow over the US$1.23b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Controladora Vuela Compañía de Aviación. de would likely require a major re-capitalisation if it had to pay its creditors today. Given that Controladora Vuela Compañía de Aviación. de has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Shareholders should be aware that Controladora Vuela Compañía de Aviación. de's EBIT was down 55% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Controladora Vuela Compañía de Aviación. de 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Controladora Vuela Compañía de Aviación. de has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Controladora Vuela Compañía de Aviación. de actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Controladora Vuela Compañía de Aviación. de's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$508.1m. And it impressed us with free cash flow of US$400m, being 177% of its EBIT. Despite the cash, we do find Controladora Vuela Compañía de Aviación. de's level of total liabilities concerning, so we're not particularly comfortable with the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Controladora Vuela Compañía de Aviación. de you should be aware of.

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.