Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Perfect Optronics Limited (HKG:8311) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Perfect Optronics Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Perfect Optronics had debt of HK$8.07m, up from HK$943.0k in one year. However, it does have HK$74.3m in cash offsetting this, leading to net cash of HK$66.2m.
A Look At Perfect Optronics's Liabilities
We can see from the most recent balance sheet that Perfect Optronics had liabilities of HK$25.1m falling due within a year, and liabilities of HK$11.0m due beyond that. On the other hand, it had cash of HK$74.3m and HK$5.29m worth of receivables due within a year. So it can boast HK$43.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Perfect Optronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Perfect Optronics has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Perfect Optronics'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.
In the last year Perfect Optronics actually shrunk its revenue by 22%, to HK$242m. That makes us nervous, to say the least.
So How Risky Is Perfect Optronics?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Perfect Optronics had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through HK$36m of cash and made a loss of HK$50m. But at least it has HK$74m on the balance sheet to spend on growth, near-term. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Perfect Optronics's profit, revenue, and operating cashflow have changed over the last few years.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.