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.' 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, AerCap Holdings N.V. (NYSE:AER) does carry debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is AerCap Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that AerCap Holdings had debt of US$27.6b at the end of September 2021, a reduction from US$31.3b over a year. However, it does have US$1.32b in cash offsetting this, leading to net debt of about US$26.3b.
How Healthy Is AerCap Holdings' Balance Sheet?
We can see from the most recent balance sheet that AerCap Holdings had liabilities of US$2.16b falling due within a year, and liabilities of US$29.4b due beyond that. Offsetting these obligations, it had cash of US$1.32b as well as receivables valued at US$2.12b due within 12 months. So it has liabilities totalling US$28.1b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$13.0b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, AerCap Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 12.5 hit our confidence in AerCap Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Investors should also be troubled by the fact that AerCap Holdings saw its EBIT drop by 16% over the last twelve months. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine AerCap Holdings's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, AerCap Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
To be frank both AerCap Holdings's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like AerCap Holdings carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with AerCap Holdings (including 2 which are potentially serious) .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
What are the risks and opportunities for AerCap Holdings?
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
AerCap Holdings N.V. engages in the lease, financing, sale, and management of commercial flight equipment in China, Hong Kong, Macau, the United States, Ireland, and internationally.
Moderate growth potential and slightly overvalued.