Transtech Optelecom Science Holdings (HKG:9963) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Transtech Optelecom Science Holdings Limited (HKG:9963) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Transtech Optelecom Science Holdings

How Much Debt Does Transtech Optelecom Science Holdings Carry?

The image below, which you can click on for greater detail, shows that Transtech Optelecom Science Holdings had debt of HK$14.1m at the end of December 2020, a reduction from HK$27.8m over a year. However, it does have HK$28.6m in cash offsetting this, leading to net cash of HK$14.6m.

A Look At Transtech Optelecom Science Holdings' Liabilities

According to the last reported balance sheet, Transtech Optelecom Science Holdings had liabilities of HK$47.3m due within 12 months, and liabilities of HK$5.33m due beyond 12 months. Offsetting this, it had HK$28.6m in cash and HK$326.2m in receivables that were due within 12 months. So it can boast HK$302.2m more liquid assets than total liabilities.

This surplus strongly suggests that Transtech Optelecom Science Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Transtech Optelecom Science Holdings 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 Transtech Optelecom Science Holdings if management cannot prevent a repeat of the 79% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Transtech Optelecom Science Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Transtech Optelecom Science Holdings 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, Transtech Optelecom Science Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Transtech Optelecom Science Holdings has HK$14.6m in net cash and a decent-looking balance sheet. So we don't have any problem with Transtech Optelecom Science Holdings's use of debt. 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. For instance, we've identified 1 warning sign for Transtech Optelecom Science Holdings that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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