Is Optical Cable (NASDAQ:OCC) Using Too Much 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.' 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 can see that Optical Cable Corporation (NASDAQ:OCC) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Optical Cable

What Is Optical Cable's Debt?

As you can see below, at the end of October 2020, Optical Cable had US$15.1m of debt, up from US$11.6m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Optical Cable's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Optical Cable had liabilities of US$6.27m due within 12 months and liabilities of US$15.0m due beyond that. Offsetting this, it had US$140.8k in cash and US$7.61m in receivables that were due within 12 months. So it has liabilities totalling US$13.5m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$21.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Optical Cable 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.

In the last year Optical Cable had a loss before interest and tax, and actually shrunk its revenue by 22%, to US$55m. To be frank that doesn't bode well.

Caveat Emptor

While Optical Cable's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$5.5m 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. Another cause for caution is that is bled US$3.7m in negative free cash flow over the last twelve months. 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. To that end, you should learn about the 4 warning signs we've spotted with Optical Cable (including 2 which are significant) .

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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