Is Sunny Optical Technology (Group) (HKG:2382) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sunny Optical Technology (Group) Company Limited (HKG:2382) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 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?

As you can see below, Sunny Optical Technology (Group) had CN¥5.72b of debt at June 2023, down from CN¥6.25b a year prior. But it also has CN¥20.6b in cash to offset that, meaning it has CN¥14.9b net cash.

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

According to the last reported balance sheet, Sunny Optical Technology (Group) had liabilities of CN¥18.2b due within 12 months, and liabilities of CN¥6.29b due beyond 12 months. Offsetting these obligations, it had cash of CN¥20.6b as well as receivables valued at CN¥6.30b due within 12 months. So it can boast CN¥2.38b 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. 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 62% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sunny Optical Technology (Group) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sunny Optical Technology (Group) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Sunny Optical Technology (Group) actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sunny Optical Technology (Group) has CN¥14.9b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 117% of that EBIT to free cash flow, bringing in CN¥4.1b. So we are not troubled with Sunny Optical Technology (Group)'s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sunny Optical Technology (Group) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.