Applied Optoelectronics (NASDAQ:AAOI) Is Carrying A Fair Bit Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Applied Optoelectronics, Inc. (NASDAQ:AAOI) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Applied Optoelectronics

How Much Debt Does Applied Optoelectronics Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Applied Optoelectronics had debt of US$149.9m, up from US$129.1m in one year. On the flip side, it has US$46.8m in cash leading to net debt of about US$103.1m.

How Strong Is Applied Optoelectronics' Balance Sheet?

The latest balance sheet data shows that Applied Optoelectronics had liabilities of US$132.3m due within a year, and liabilities of US$100.3m falling due after that. On the other hand, it had cash of US$46.8m and US$51.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$134.4m.

While this might seem like a lot, it is not so bad since Applied Optoelectronics has a market capitalization of US$269.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 ultimately the future profitability of the business will decide if Applied Optoelectronics 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.

In the last year Applied Optoelectronics wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to US$231m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Applied Optoelectronics produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$48m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$53m of cash over the last year. So suffice it to say 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. We've identified 3 warning signs with Applied Optoelectronics (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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