Is China Display Optoelectronics Technology Holdings (HKG:334) Weighed On By Its Debt Load?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies China Display Optoelectronics Technology Holdings Limited (HKG:334) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for China Display Optoelectronics Technology Holdings

What Is China Display Optoelectronics Technology Holdings's Debt?

As you can see below, China Display Optoelectronics Technology Holdings had CN¥281.6m of debt at June 2020, down from CN¥1.40b a year prior. But it also has CN¥304.3m in cash to offset that, meaning it has CN¥22.8m net cash.

How Healthy Is China Display Optoelectronics Technology Holdings's Balance Sheet?

We can see from the most recent balance sheet that China Display Optoelectronics Technology Holdings had liabilities of CN¥1.65b falling due within a year, and liabilities of CN¥86.5m due beyond that. Offsetting this, it had CN¥304.3m in cash and CN¥856.6m in receivables that were due within 12 months. So its liabilities total CN¥572.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥769.7m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, China Display Optoelectronics Technology Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, China Display Optoelectronics Technology Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥3.6b, which is a fall of 53%. 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 generated positive free cash flow CN¥791m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Display Optoelectronics Technology Holdings is showing 1 warning sign in our investment analysis , you should know about...

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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