Here's Why Universal Technologies Holdings (HKG:1026) Can Afford Some Debt

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.' 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. We can see that Universal Technologies Holdings Limited (HKG:1026) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Universal Technologies Holdings

What Is Universal Technologies Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Universal Technologies Holdings had debt of HK$947.3m, up from HK$651.2m in one year. However, it also had HK$794.9m in cash, and so its net debt is HK$152.3m.

A Look At Universal Technologies Holdings' Liabilities

According to the last reported balance sheet, Universal Technologies Holdings had liabilities of HK$315.8m due within 12 months, and liabilities of HK$946.2m due beyond 12 months. On the other hand, it had cash of HK$794.9m and HK$61.6m worth of receivables due within a year. So it has liabilities totalling HK$405.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Universal Technologies Holdings has a market capitalization of HK$953.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Universal Technologies Holdings's earnings that will influence how the balance sheet holds up in the future. 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 Universal Technologies Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to HK$377m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Universal Technologies Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$26m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of HK$52m into a profit. So in short it's a really risky stock. 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. We've identified 2 warning signs with Universal Technologies Holdings (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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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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.