Is Aerospace Industrial Development (TPE:2634) Using Too Much Debt?

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.' 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 Aerospace Industrial Development Corporation (TPE:2634) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Aerospace Industrial Development

What Is Aerospace Industrial Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Aerospace Industrial Development had NT$24.1b of debt, an increase on NT$22.3b, over one year. However, it also had NT$5.73b in cash, and so its net debt is NT$18.4b.

How Strong Is Aerospace Industrial Development's Balance Sheet?

We can see from the most recent balance sheet that Aerospace Industrial Development had liabilities of NT$21.2b falling due within a year, and liabilities of NT$9.82b due beyond that. On the other hand, it had cash of NT$5.73b and NT$9.30b worth of receivables due within a year. So it has liabilities totalling NT$16.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Aerospace Industrial Development is worth NT$27.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Aerospace Industrial Development's debt to EBITDA ratio of 9.2 suggests a heavy debt load, its interest coverage of 7.1 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Shareholders should be aware that Aerospace Industrial Development's EBIT was down 58% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Aerospace Industrial Development's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Aerospace Industrial Development burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Aerospace Industrial Development's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Aerospace Industrial Development to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Aerospace Industrial Development (1 is potentially serious) 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. 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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