Is Changchun UP OptotechLtd (SZSE:002338) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Changchun UP Optotech Co.,Ltd. (SZSE:002338) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Changchun UP OptotechLtd

What Is Changchun UP OptotechLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Changchun UP OptotechLtd had CN¥200.0m of debt, an increase on CN¥148.8m, over one year. But on the other hand it also has CN¥211.5m in cash, leading to a CN¥11.5m net cash position.

A Look At Changchun UP OptotechLtd's Liabilities

We can see from the most recent balance sheet that Changchun UP OptotechLtd had liabilities of CN¥330.7m falling due within a year, and liabilities of CN¥293.5m due beyond that. On the other hand, it had cash of CN¥211.5m and CN¥381.8m worth of receivables due within a year. So it has liabilities totalling CN¥30.9m more than its cash and near-term receivables, combined.

This state of affairs indicates that Changchun UP OptotechLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥7.59b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Changchun UP OptotechLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Changchun UP OptotechLtd saw its EBIT decline by 8.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Changchun UP OptotechLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Changchun UP OptotechLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Changchun UP OptotechLtd's free cash flow amounted to 32% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Changchun UP OptotechLtd has CN¥11.5m in net cash. So we are not troubled with Changchun UP OptotechLtd's debt use. 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 instance, we've identified 1 warning sign for Changchun UP OptotechLtd that you should be aware of.

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.

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