Is Electro Optic Systems Holdings (ASX:EOS) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Electro Optic Systems Holdings Limited (ASX:EOS) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Electro Optic Systems Holdings

What Is Electro Optic Systems Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Electro Optic Systems Holdings had debt of AU$72.7m, up from AU$34.4m in one year. However, it does have AU$21.7m in cash offsetting this, leading to net debt of about AU$51.1m.

A Look At Electro Optic Systems Holdings' Liabilities

We can see from the most recent balance sheet that Electro Optic Systems Holdings had liabilities of AU$104.8m falling due within a year, and liabilities of AU$79.5m due beyond that. Offsetting these obligations, it had cash of AU$21.7m as well as receivables valued at AU$147.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$15.1m.

Since publicly traded Electro Optic Systems Holdings shares are worth a total of AU$156.7m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Electro Optic Systems Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Electro Optic Systems Holdings made a loss at the EBIT level, and saw its revenue drop to AU$138m, which is a fall of 35%. That makes us nervous, to say the least.

Caveat Emptor

While Electro Optic Systems Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping AU$55m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$71m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Electro Optic Systems Holdings that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.