Here's Why Sunny Optical Technology (Group) (HKG:2382) Can Manage Its Debt Responsibly

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 should shareholders be worried about its use of debt?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 2382 is potentially undervalued!

How Much Debt Does Sunny Optical Technology (Group) Carry?

As you can see below, Sunny Optical Technology (Group) had CN¥6.25b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥14.4b in cash to offset that, meaning it has CN¥8.18b net cash.

A Look At Sunny Optical Technology (Group)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Sunny Optical Technology (Group) had liabilities of CN¥15.0b due within 12 months and liabilities of CN¥2.23b due beyond that. On the other hand, it had cash of CN¥14.4b and CN¥7.18b worth of receivables due within a year. So it can boast CN¥4.41b more liquid assets than total liabilities.

This short term liquidity is a sign that Sunny Optical Technology (Group) could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sunny Optical Technology (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Sunny Optical Technology (Group)'s load is not too heavy, because its EBIT was down 44% 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're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, Sunny Optical Technology (Group) recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sunny Optical Technology (Group) has CN¥8.18b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CN¥3.3b. So we are not troubled with Sunny Optical Technology (Group)'s debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Sunny Optical Technology (Group), you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.