David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. Importantly, Air T, Inc. (NASDAQ:AIRT) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Air T

How Much Debt Does Air T Carry?

As you can see below, at the end of June 2019, Air T had US$64.1m of debt, up from US$40.9m a year ago. Click the image for more detail. However, it does have US$17.9m in cash offsetting this, leading to net debt of about US$46.1m.

How Strong Is Air T's Balance Sheet?

The latest balance sheet data shows that Air T had liabilities of US$60.4m due within a year, and liabilities of US$45.6m falling due after that. Offsetting these obligations, it had cash of US$17.9m as well as receivables valued at US$31.8m due within 12 months. So it has liabilities totalling US$56.3m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$52.7m, we think shareholders really should watch Air T's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Air T's debt to EBITDA ratio (3.1) suggests that it uses some debt, its interest cover is very weak, at 1.9, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Air T grew its EBIT a smooth 36% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Air T'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.