Is Air New Zealand (NZSE:AIR) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Air New Zealand Limited (NZSE:AIR) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Air New Zealand

What Is Air New Zealand's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Air New Zealand had debt of NZ$1.78b, up from NZ$1.58b in one year. However, it does have NZ$156.0m in cash offsetting this, leading to net debt of about NZ$1.63b.

How Healthy Is Air New Zealand's Balance Sheet?

The latest balance sheet data shows that Air New Zealand had liabilities of NZ$2.65b due within a year, and liabilities of NZ$2.99b falling due after that. On the other hand, it had cash of NZ$156.0m and NZ$287.0m worth of receivables due within a year. So its liabilities total NZ$5.20b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the NZ$1.45b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Air New Zealand would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Air New Zealand 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 New Zealand made a loss at the EBIT level, and saw its revenue drop to NZ$2.4b, which is a fall of 21%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Air New Zealand's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable NZ$553m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost NZ$488m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's 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. For instance, we've identified 2 warning signs for Air New Zealand that you should be aware of.

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.