Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Ching Chan Optical Technology Co., Ltd. (GTSM:2070) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Ching Chan Optical Technology
What Is Ching Chan Optical Technology’s Debt?
As you can see below, Ching Chan Optical Technology had NT$331.8m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have NT$353.2m in cash offsetting this, leading to net cash of NT$21.4m.
How Strong Is Ching Chan Optical Technology’s Balance Sheet?
We can see from the most recent balance sheet that Ching Chan Optical Technology had liabilities of NT$398.4m falling due within a year, and liabilities of NT$385.5m due beyond that. On the other hand, it had cash of NT$353.2m and NT$131.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$299.6m.
Ching Chan Optical Technology has a market capitalization of NT$1.02b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Ching Chan Optical Technology boasts net cash, so it’s fair to say it does not have a heavy debt load! There’s no doubt that we learn most about debt from the balance sheet. But it is Ching Chan Optical Technology’s earnings that will influence how the balance sheet holds up in the future. 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 Ching Chan Optical Technology had a loss before interest and tax, and actually shrunk its revenue by 39%, to NT$461m. To be frank that doesn’t bode well.
So How Risky Is Ching Chan Optical Technology?
While Ching Chan Optical Technology lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow NT$142m. So taking that on face value, and considering the net cash situation, we don’t think that the stock is too risky in the near term. With revenue growth uninspiring, we’d really need to see some positive EBIT before mustering much enthusiasm for this business. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. These risks can be hard to spot. Every company has them, and we’ve spotted 3 warning signs for Ching Chan Optical Technology (of which 1 makes us a bit uncomfortable!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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