Does Sunny Optical Technology (Group) (HKG:2382) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Sunny Optical Technology (Group) Company Limited (HKG:2382) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sunny Optical Technology (Group)

What Is Sunny Optical Technology (Group)'s Net Debt?

The image below, which you can click on for greater detail, shows that Sunny Optical Technology (Group) had debt of CN¥5.56b at the end of December 2023, a reduction from CN¥6.20b over a year. But it also has CN¥21.5b in cash to offset that, meaning it has CN¥15.9b net cash.

How Strong Is Sunny Optical Technology (Group)'s Balance Sheet?

The latest balance sheet data shows that Sunny Optical Technology (Group) had liabilities of CN¥21.3b due within a year, and liabilities of CN¥6.13b falling due after that. Offsetting this, it had CN¥21.5b in cash and CN¥7.92b in receivables that were due within 12 months. So it actually has CN¥2.02b more liquid assets than total liabilities.

This surplus suggests that Sunny Optical Technology (Group) has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sunny Optical Technology (Group) has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Sunny Optical Technology (Group) if management cannot prevent a repeat of the 77% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sunny Optical Technology (Group)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sunny Optical 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. Happily for any shareholders, Sunny Optical Technology (Group) actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sunny Optical Technology (Group) has net cash of CN¥15.9b, as well as more liquid assets than liabilities. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in CN¥177m. So we are not troubled with Sunny Optical Technology (Group)'s debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Sunny Optical Technology (Group) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.