Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Universal Technologies Holdings Limited (HKG:1026) does carry debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is Universal Technologies Holdings's Debt?
As you can see below, Universal Technologies Holdings had HK$572.6m of debt at June 2019, down from HK$766.2m a year prior. But it also has HK$1.12b in cash to offset that, meaning it has HK$545.5m net cash.
How Strong Is Universal Technologies Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Universal Technologies Holdings had liabilities of HK$133.4m due within 12 months and liabilities of HK$611.4m due beyond that. Offsetting this, it had HK$1.12b in cash and HK$23.3m in receivables that were due within 12 months. So it can boast HK$396.7m more liquid assets than total liabilities.
This luscious liquidity implies that Universal Technologies Holdings's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Universal Technologies Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Universal Technologies Holdings will need earnings to service that debt. 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 Universal Technologies Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 4.3%, to HK$268m. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Universal Technologies Holdings?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Universal Technologies Holdings lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through HK$78m of cash and made a loss of HK$22m. While this does make the company a bit risky, it's important to remember it has net cash of HK$545.5m. That means it could keep spending at its current rate for more than two years. 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Universal Technologies Holdings (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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