Health Check: How Prudently Does Arts Optical International Holdings (HKG:1120) Use Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Arts Optical International Holdings Limited (HKG:1120) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Arts Optical International Holdings

How Much Debt Does Arts Optical International Holdings Carry?

The image below, which you can click on for greater detail, shows that Arts Optical International Holdings had debt of HK$19.8m at the end of December 2020, a reduction from HK$25.3m over a year. But on the other hand it also has HK$212.6m in cash, leading to a HK$192.8m net cash position.

How Healthy Is Arts Optical International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Arts Optical International Holdings had liabilities of HK$433.9m falling due within a year, and liabilities of HK$11.5m due beyond that. On the other hand, it had cash of HK$212.6m and HK$229.3m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Arts Optical International Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the HK$305.1m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Arts Optical International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Arts 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.

In the last year Arts Optical International Holdings had a loss before interest and tax, and actually shrunk its revenue by 29%, to HK$743m. To be frank that doesn't bode well.

So How Risky Is Arts Optical International Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Arts Optical International Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$102m and booked a HK$512m accounting loss. With only HK$192.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Arts Optical International Holdings you should be aware of, and 1 of them is significant.

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. 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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