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.' 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. As with many other companies Ocean Star Technology Group Limited (HKG:8297) makes use of debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. 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.
How Much Debt Does Ocean Star Technology Group Carry?
As you can see below, at the end of September 2021, Ocean Star Technology Group had HK$17.9m of debt, up from none a year ago. Click the image for more detail. But it also has HK$28.2m in cash to offset that, meaning it has HK$10.4m net cash.
A Look At Ocean Star Technology Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Ocean Star Technology Group had liabilities of HK$86.1m due within 12 months and liabilities of HK$8.34m due beyond that. On the other hand, it had cash of HK$28.2m and HK$15.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$50.4m.
While this might seem like a lot, it is not so bad since Ocean Star Technology Group has a market capitalization of HK$95.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Ocean Star Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!
We also note that Ocean Star Technology Group improved its EBIT from a last year's loss to a positive HK$3.7m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ocean Star Technology Group 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ocean Star Technology Group 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. During the last year, Ocean Star Technology Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While Ocean Star Technology Group does have more liabilities than liquid assets, it also has net cash of HK$10.4m. So although we see some areas for improvement, we're not too worried about Ocean Star Technology Group's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Ocean Star Technology Group (of which 1 is a bit unpleasant!) you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.