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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies AIREA plc (LON:AIEA) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is AIREA's Net Debt?
As you can see below, at the end of June 2021, AIREA had UK£4.27m of debt, up from UK£3.90m a year ago. Click the image for more detail. But it also has UK£6.23m in cash to offset that, meaning it has UK£1.96m net cash.
How Healthy Is AIREA's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that AIREA had liabilities of UK£5.32m due within 12 months and liabilities of UK£4.29m due beyond that. Offsetting this, it had UK£6.23m in cash and UK£2.09m in receivables that were due within 12 months. So it has liabilities totalling UK£1.29m more than its cash and near-term receivables, combined.
Of course, AIREA has a market capitalization of UK£11.4m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, AIREA also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that AIREA saw its EBIT decline by 9.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is AIREA's earnings that will influence how the balance sheet holds up in the future. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AIREA 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. Over the last three years, AIREA recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While AIREA does have more liabilities than liquid assets, it also has net cash of UK£1.96m. And it impressed us with free cash flow of -UK£235k, being 90% of its EBIT. So we don't have any problem with AIREA's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for AIREA you should be aware of, and 1 of them is significant.
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.
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.
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