The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Hainan Meilan International Airport Company Limited (HKG:357) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Hainan Meilan International Airport
What Is Hainan Meilan International Airport's Net Debt?
As you can see below, at the end of June 2023, Hainan Meilan International Airport had CN¥2.24b of debt, up from CN¥1.96b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥315.8m, its net debt is less, at about CN¥1.93b.
How Healthy Is Hainan Meilan International Airport's Balance Sheet?
We can see from the most recent balance sheet that Hainan Meilan International Airport had liabilities of CN¥6.45b falling due within a year, and liabilities of CN¥1.27b due beyond that. On the other hand, it had cash of CN¥315.8m and CN¥433.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.97b.
This deficit casts a shadow over the CN¥2.92b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Hainan Meilan International Airport would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hainan Meilan International Airport'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.
Over 12 months, Hainan Meilan International Airport reported revenue of CN¥1.6b, which is a gain of 19%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Importantly, Hainan Meilan International Airport had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥155m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥194m. And until that time we think this is a risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hainan Meilan International Airport is showing 1 warning sign in our investment analysis , you should know about...
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. 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.