Is Hangzhou Mdk Opto ElectronicsLtd (SHSE:688079) Using Too Much Debt?

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.' 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 can see that Hangzhou Mdk Opto Electronics Co.,Ltd. (SHSE:688079) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hangzhou Mdk Opto ElectronicsLtd

What Is Hangzhou Mdk Opto ElectronicsLtd's Net Debt?

As you can see below, at the end of June 2024, Hangzhou Mdk Opto ElectronicsLtd had CN¥771.1m of debt, up from CN¥345.4m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥117.0m, its net debt is less, at about CN¥654.1m.

How Healthy Is Hangzhou Mdk Opto ElectronicsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hangzhou Mdk Opto ElectronicsLtd had liabilities of CN¥551.6m due within 12 months and liabilities of CN¥541.5m due beyond that. Offsetting these obligations, it had cash of CN¥117.0m as well as receivables valued at CN¥71.9m due within 12 months. So it has liabilities totalling CN¥904.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Hangzhou Mdk Opto ElectronicsLtd is worth CN¥3.75b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hangzhou Mdk Opto ElectronicsLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hangzhou Mdk Opto ElectronicsLtd made a loss at the EBIT level, and saw its revenue drop to CN¥365m, which is a fall of 3.1%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Hangzhou Mdk Opto ElectronicsLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥99m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥597m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Hangzhou Mdk Opto ElectronicsLtd (2 don't sit too well with us!) that you should be aware of before investing here.

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.

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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.