Is Applied Optoelectronics (NASDAQ:AAOI) Weighed On By Its Debt Load?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that Applied Optoelectronics, Inc. (NASDAQ:AAOI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. 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 Applied Optoelectronics

How Much Debt Does Applied Optoelectronics Carry?

As you can see below, Applied Optoelectronics had US$142.9m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$33.7m in cash offsetting this, leading to net debt of about US$109.3m.

How Strong Is Applied Optoelectronics' Balance Sheet?

We can see from the most recent balance sheet that Applied Optoelectronics had liabilities of US$129.8m falling due within a year, and liabilities of US$85.3m due beyond that. On the other hand, it had cash of US$33.7m and US$49.4m worth of receivables due within a year. So its liabilities total US$132.1m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$61.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Applied Optoelectronics would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Applied Optoelectronics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Applied Optoelectronics made a loss at the EBIT level, and saw its revenue drop to US$212m, which is a fall of 8.9%. We would much prefer see growth.

Caveat Emptor

Importantly, Applied Optoelectronics had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$56m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$6.9m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Be aware that Applied Optoelectronics is showing 3 warning signs in our investment analysis , you should know about...

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.