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.' 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 AVIC Heavy Machinery Co., Ltd. (SHSE:600765) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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, 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.
See our latest analysis for AVIC Heavy Machinery
What Is AVIC Heavy Machinery's Net Debt?
The image below, which you can click on for greater detail, shows that AVIC Heavy Machinery had debt of CN¥2.71b at the end of September 2022, a reduction from CN¥2.87b over a year. But it also has CN¥4.93b in cash to offset that, meaning it has CN¥2.22b net cash.
How Healthy Is AVIC Heavy Machinery's Balance Sheet?
According to the last reported balance sheet, AVIC Heavy Machinery had liabilities of CN¥9.05b due within 12 months, and liabilities of CN¥1.18b due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.93b as well as receivables valued at CN¥7.37b due within 12 months. So it actually has CN¥2.06b more liquid assets than total liabilities.
This short term liquidity is a sign that AVIC Heavy Machinery could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, AVIC Heavy Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that AVIC Heavy Machinery has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AVIC Heavy Machinery can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While AVIC Heavy Machinery has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, AVIC Heavy Machinery's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case AVIC Heavy Machinery has CN¥2.22b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 31% over the last year. So is AVIC Heavy Machinery's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with AVIC Heavy Machinery .
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.
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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.