Is Elegance Optical International Holdings (HKG:907) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Elegance Optical International Holdings Limited (HKG:907) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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

View our latest analysis for Elegance Optical International Holdings

What Is Elegance Optical International Holdings's Debt?

As you can see below, at the end of March 2024, Elegance Optical International Holdings had HK$13.1m of debt, up from none a year ago. Click the image for more detail. However, because it has a cash reserve of HK$7.05m, its net debt is less, at about HK$6.09m.

How Strong Is Elegance Optical International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Elegance Optical International Holdings had liabilities of HK$72.8m falling due within a year, and liabilities of HK$1.13m due beyond that. Offsetting this, it had HK$7.05m in cash and HK$14.2m in receivables that were due within 12 months. So it has liabilities totalling HK$52.7m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$48.0m, we think shareholders really should watch Elegance Optical International Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But it is Elegance Optical International Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Elegance Optical International Holdings reported revenue of HK$24m, which is a gain of 11%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Elegance Optical International Holdings produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$49m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through HK$20m in negative free cash flow over the last year. That means it's on the risky side of things. 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 Elegance Optical International Holdings has 4 warning signs (and 2 which are potentially serious) we think 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.