Arima Optoelectronics (TPE:6289) Is Carrying A Fair Bit Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Arima Optoelectronics Corp. (TPE:6289) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Arima Optoelectronics

What Is Arima Optoelectronics's Debt?

The chart below, which you can click on for greater detail, shows that Arima Optoelectronics had NT$45.5m in debt in September 2020; about the same as the year before. However, because it has a cash reserve of NT$38.3m, its net debt is less, at about NT$7.21m.

How Healthy Is Arima Optoelectronics' Balance Sheet?

We can see from the most recent balance sheet that Arima Optoelectronics had liabilities of NT$188.2m falling due within a year, and liabilities of NT$35.6m due beyond that. On the other hand, it had cash of NT$38.3m and NT$32.3m worth of receivables due within a year. So it has liabilities totalling NT$153.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Arima Optoelectronics is worth NT$314.3m, 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Arima Optoelectronics will need earnings to service that debt. 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 Arima Optoelectronics had a loss before interest and tax, and actually shrunk its revenue by 38%, to NT$77m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Arima Optoelectronics's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable NT$141m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NT$44m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Arima Optoelectronics is showing 5 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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