Focused Photonics (Hangzhou) (SZSE:300203) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, Focused Photonics (Hangzhou), Inc. (SZSE:300203) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Focused Photonics (Hangzhou)

What Is Focused Photonics (Hangzhou)'s Debt?

You can click the graphic below for the historical numbers, but it shows that Focused Photonics (Hangzhou) had CN¥3.46b of debt in September 2024, down from CN¥3.88b, one year before. However, it does have CN¥1.01b in cash offsetting this, leading to net debt of about CN¥2.45b.

How Healthy Is Focused Photonics (Hangzhou)'s Balance Sheet?

The latest balance sheet data shows that Focused Photonics (Hangzhou) had liabilities of CN¥3.50b due within a year, and liabilities of CN¥2.62b falling due after that. Offsetting this, it had CN¥1.01b in cash and CN¥1.26b in receivables that were due within 12 months. So its liabilities total CN¥3.85b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Focused Photonics (Hangzhou) is worth CN¥8.52b, and thus could probably raise enough capital to shore up 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Focused Photonics (Hangzhou) shareholders face the double whammy of a high net debt to EBITDA ratio (13.9), and fairly weak interest coverage, since EBIT is just 0.42 times the interest expense. The debt burden here is substantial. However, the silver lining was that Focused Photonics (Hangzhou) achieved a positive EBIT of CN¥22m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Focused Photonics (Hangzhou)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Focused Photonics (Hangzhou) actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Focused Photonics (Hangzhou)'s interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that Focused Photonics (Hangzhou)'s debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Focused Photonics (Hangzhou) has 1 warning sign we think 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.