Is China Display Optoelectronics Technology Holdings (HKG:334) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, China Display Optoelectronics Technology Holdings Limited (HKG:334) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View 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 it also has CN¥416.7m in cash to offset that, meaning it has CN¥194.4m net cash.

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

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 these obligations, it had cash of CN¥416.7m as well as receivables valued at CN¥1.01b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥934.8m.

This deficit is considerable relative to its market capitalization of CN¥1.06b, so it does suggest shareholders should keep an eye on China Display Optoelectronics Technology Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Display Optoelectronics Technology Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year China Display Optoelectronics Technology Holdings had a loss before interest and tax, and actually shrunk its revenue by 20%, to CN¥4.4b. That makes us nervous, to say the least.

So How Risky Is China Display Optoelectronics Technology Holdings?

Although China Display Optoelectronics Technology Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥25m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short 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. To that end, you should learn about the 3 warning signs we've spotted with China Display Optoelectronics Technology Holdings (including 1 which can't be ignored) .

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. 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.
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