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. We can see that Applied Optoelectronics, Inc. (NASDAQ:AAOI) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Applied Optoelectronics Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Applied Optoelectronics had US$128.8m of debt, an increase on US$61.0m, over one year. However, it also had US$81.1m in cash, and so its net debt is US$47.7m.
A Look At Applied Optoelectronics's Liabilities
We can see from the most recent balance sheet that Applied Optoelectronics had liabilities of US$68.1m falling due within a year, and liabilities of US$115.3m due beyond that. Offsetting these obligations, it had cash of US$81.1m as well as receivables valued at US$28.5m due within 12 months. So it has liabilities totalling US$73.8m more than its cash and near-term receivables, combined.
Applied Optoelectronics has a market capitalization of US$208.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Applied Optoelectronics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Applied Optoelectronics made a loss at the EBIT level, and saw its revenue drop to US$211m, which is a fall of 35%. That makes us nervous, to say the least.
Not only did Applied Optoelectronics's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$48m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$65m of cash over the last year. So suffice it to say we consider the stock very risky. For riskier companies like Applied Optoelectronics I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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