Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Unicon Optical Co., Ltd. (GTSM:4150) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Unicon Optical Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Unicon Optical had NT$436.9m of debt, an increase on NT$226.9m, over one year. However, it also had NT$189.6m in cash, and so its net debt is NT$247.2m.
A Look At Unicon Optical's Liabilities
According to the last reported balance sheet, Unicon Optical had liabilities of NT$1.14b due within 12 months, and liabilities of NT$526.0m due beyond 12 months. Offsetting this, it had NT$189.6m in cash and NT$478.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$999.8m.
This deficit isn't so bad because Unicon Optical is worth NT$1.81b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Unicon Optical 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.
In the last year Unicon Optical wasn't profitable at an EBIT level, but managed to grow its revenue by 28%, to NT$1.3b. Shareholders probably have their fingers crossed that it can grow its way to profits.
Even though Unicon Optical managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping NT$355m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of NT$326m. In the meantime, we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Unicon Optical (of which 1 is significant!) you should know about.
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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