Universal Technologies Holdings (HKG:1026) Has Debt But No Earnings; Should You Worry?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Universal Technologies Holdings Limited (HKG:1026) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. 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 Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Universal Technologies Holdings had HK$1.01b of debt, an increase on HK$947.3m, over one year. However, it also had HK$777.3m in cash, and so its net debt is HK$236.2m.

How Healthy Is Universal Technologies Holdings' Balance Sheet?

According to the last reported balance sheet, Universal Technologies Holdings had liabilities of HK$583.2m due within 12 months, and liabilities of HK$871.6m due beyond 12 months. Offsetting this, it had HK$777.3m in cash and HK$45.7m in receivables that were due within 12 months. So it has liabilities totalling HK$631.7m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$623.0m, we think shareholders really should watch Universal Technologies Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Universal Technologies 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.

Over 12 months, Universal Technologies Holdings made a loss at the EBIT level, and saw its revenue drop to HK$364m, which is a fall of 3.3%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Universal Technologies Holdings produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$49m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$57m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. Be aware that Universal Technologies Holdings is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.