Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, China Airlines, Ltd. (TPE:2610) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does China Airlines Carry?
As you can see below, at the end of September 2020, China Airlines had NT$122.7b of debt, up from NT$101.4b a year ago. Click the image for more detail. On the flip side, it has NT$32.6b in cash leading to net debt of about NT$90.1b.
How Strong Is China Airlines's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Airlines had liabilities of NT$66.1b due within 12 months and liabilities of NT$159.9b due beyond that. Offsetting this, it had NT$32.6b in cash and NT$9.13b in receivables that were due within 12 months. So it has liabilities totalling NT$184.2b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the NT$56.9b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Airlines would likely require a major re-capitalisation if it had to pay its creditors today. 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 China Airlines'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.
In the last year China Airlines had a loss before interest and tax, and actually shrunk its revenue by 25%, to NT$128b. To be frank that doesn't bode well.
While China Airlines's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$711m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely since it is low on liquid assets, and made a loss of NT$2.9b in the last year. So we think this stock is quite risky. We'd prefer to pass. 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 1 warning sign for China Airlines that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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