We Think Opto Tech (TPE:2340) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Opto Tech Corporation (TPE:2340) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Opto Tech

How Much Debt Does Opto Tech Carry?

The chart below, which you can click on for greater detail, shows that Opto Tech had NT$1.04b in debt in December 2020; about the same as the year before. However, its balance sheet shows it holds NT$3.42b in cash, so it actually has NT$2.38b net cash.

How Healthy Is Opto Tech's Balance Sheet?

We can see from the most recent balance sheet that Opto Tech had liabilities of NT$1.73b falling due within a year, and liabilities of NT$1.21b due beyond that. On the other hand, it had cash of NT$3.42b and NT$1.68b worth of receivables due within a year. So it actually has NT$2.15b more liquid assets than total liabilities.

This surplus suggests that Opto Tech is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Opto Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Opto Tech saw its EBIT decline by 6.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Opto Tech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Opto Tech 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, Opto Tech recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Opto Tech has net cash of NT$2.38b, as well as more liquid assets than liabilities. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in NT$592m. So is Opto Tech's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 2 warning signs we've spotted with Opto Tech (including 1 which is concerning) .

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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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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