Optima Automobile Group Holdings (HKG:8418) Has Debt But No Earnings; Should You Worry?

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.' 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. We can see that Optima Automobile Group Holdings Limited (HKG:8418) 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that 8418 is potentially overvalued!

How Much Debt Does Optima Automobile Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Optima Automobile Group Holdings had S$6.89m of debt, an increase on S$1.00m, over one year. But it also has S$10.5m in cash to offset that, meaning it has S$3.66m net cash.

A Look At Optima Automobile Group Holdings' Liabilities

The latest balance sheet data shows that Optima Automobile Group Holdings had liabilities of S$14.7m due within a year, and liabilities of S$7.14m falling due after that. Offsetting these obligations, it had cash of S$10.5m as well as receivables valued at S$2.16m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$9.18m.

Since publicly traded Optima Automobile Group Holdings shares are worth a total of S$121.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Optima Automobile Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Optima Automobile Group Holdings 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, Optima Automobile Group Holdings reported revenue of S$84m, which is a gain of 173%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

So How Risky Is Optima Automobile Group Holdings?

While Optima Automobile Group Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow S$435k. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that Optima Automobile Group Holdings is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock is risky. 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. For example, we've discovered 2 warning signs for Optima Automobile Group Holdings (1 is potentially serious!) 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.