Would Contel Technology (HKG:1912) Be Better Off With Less Debt?

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.' 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 Contel Technology Company Limited (HKG:1912) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Contel Technology

What Is Contel Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Contel Technology had US$10.8m of debt, an increase on US$5.58m, over one year. However, it also had US$3.38m in cash, and so its net debt is US$7.39m.

How Healthy Is Contel Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Contel Technology had liabilities of US$26.4m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of US$3.38m as well as receivables valued at US$18.5m due within 12 months. So it has liabilities totalling US$4.50m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Contel Technology is worth US$7.70m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Contel Technology'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, Contel Technology made a loss at the EBIT level, and saw its revenue drop to US$82m, which is a fall of 53%. To be frank that doesn't bode well.

Caveat Emptor

While Contel Technology's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$4.9m. 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. We would feel better if it turned its trailing twelve month loss of US$5.7m into a profit. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Contel Technology is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...

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.