Is Optivision Technology (GTSM:3666) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Optivision Technology, Inc. (GTSM:3666) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Optivision Technology

How Much Debt Does Optivision Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Optivision Technology had NT$375.2m of debt, an increase on NT$245.4m, over one year. However, it does have NT$916.8m in cash offsetting this, leading to net cash of NT$541.7m.

How Healthy Is Optivision Technology's Balance Sheet?

The latest balance sheet data shows that Optivision Technology had liabilities of NT$740.9m due within a year, and liabilities of NT$37.1m falling due after that. Offsetting this, it had NT$916.8m in cash and NT$931.2m in receivables that were due within 12 months. So it can boast NT$1.07b more liquid assets than total liabilities.

This surplus strongly suggests that Optivision Technology has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Optivision Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Optivision Technology made a loss at the EBIT level, last year, it was also good to see that it generated NT$120m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Optivision Technology 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 Optivision Technology 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 year, Optivision Technology recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Optivision Technology has net cash of NT$541.7m, as well as more liquid assets than liabilities. So we don't have any problem with Optivision Technology's use of debt. 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. For example, we've discovered 4 warning signs for Optivision Technology (1 is potentially serious!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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