Does China Display Optoelectronics Technology Holdings (HKG:334) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, China Display Optoelectronics Technology Holdings Limited (HKG:334) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Display Optoelectronics Technology Holdings

How Much Debt Does China Display Optoelectronics Technology Holdings Carry?

As you can see below, China Display Optoelectronics Technology Holdings had CN¥222.3m of debt at December 2020, down from CN¥1.04b a year prior. But on the other hand it also has CN¥499.1m in cash, leading to a CN¥276.7m net cash position.

A Look At China Display Optoelectronics Technology Holdings' Liabilities

According to the last reported balance sheet, China Display Optoelectronics Technology Holdings had liabilities of CN¥2.27b due within 12 months, and liabilities of CN¥90.6m due beyond 12 months. Offsetting this, it had CN¥499.1m in cash and CN¥1.01b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥852.5m.

This deficit is considerable relative to its market capitalization of CN¥941.2m, so it does suggest shareholders should keep an eye on China Display Optoelectronics Technology Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, China Display Optoelectronics Technology Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Display Optoelectronics Technology Holdings'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.

Over 12 months, China Display Optoelectronics Technology Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥4.4b, which is a fall of 20%. To be frank that doesn't bode well.

So How Risky Is China Display Optoelectronics Technology Holdings?

While China Display Optoelectronics Technology Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥25m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for China Display Optoelectronics Technology Holdings that you should be aware of.

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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