Is Air Asia (TWSE:2630) 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. Importantly, Air Asia Co., Ltd. (TWSE:2630) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Air Asia

How Much Debt Does Air Asia Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Air Asia had NT$1.87b of debt, an increase on NT$1.43b, over one year. However, it does have NT$219.1m in cash offsetting this, leading to net debt of about NT$1.65b.

A Look At Air Asia's Liabilities

Zooming in on the latest balance sheet data, we can see that Air Asia had liabilities of NT$2.42b due within 12 months and liabilities of NT$604.1m due beyond that. On the other hand, it had cash of NT$219.1m and NT$3.57b worth of receivables due within a year. So it can boast NT$766.5m more liquid assets than total liabilities.

This surplus suggests that Air Asia has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 6.0, it's fair to say Air Asia does have a significant amount of debt. However, its interest coverage of 7.0 is reasonably strong, which is a good sign. Notably, Air Asia's EBIT launched higher than Elon Musk, gaining a whopping 190% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Air Asia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Air Asia 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

Air Asia's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But its EBIT growth rate was significantly redeeming. Considering this range of data points, we think Air Asia is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 Air Asia 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.