Is Elegance Optical International Holdings (HKG:907) a risky investment?

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Elegance Optical International Holdings Limited (HKG:907) uses debt. But does this debt worry shareholders?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Elegance Optical International Holdings

What is the net debt of Elegance Optical International Holdings?

As you can see below, at the end of September 2021, Elegance Optical International Holdings had a debt of HK$38.0 million, compared to HK$28.9 million a year ago. Click on the image for more details. But on the other hand, it also has HK$100.0 million in cash, resulting in a net cash position of HK$62.1 million.

SEHK: 907 Historical Debt to Equity February 3, 2022

How healthy is Elegance Optical International Holdings’ balance sheet?

The latest balance sheet data shows that Elegance Optical International Holdings had liabilities of HK$81.3 million due within the year, and liabilities of HK$35.4 million falling due thereafter. As compensation for these obligations, it had cash of HK$100.0 million and receivables valued at HK$16.4 million due within 12 months. These liquid assets therefore roughly correspond to the total liabilities.

Given the size of Elegance Optical International Holdings, it appears that its cash is well balanced against its total liabilities. It is therefore very unlikely that the HK$462.6 million company will run out of cash, but it is still worth keeping an eye on the balance sheet. Despite its notable liabilities, Elegance Optical International Holdings has net cash, so it’s fair to say that it doesn’t have heavy debt! There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Elegance Optical International Holdings that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Last year, Elegance Optical International Holdings recorded a loss before interest and tax and actually reduced its revenue by 29% to HK$45 million. To be honest, that doesn’t bode well.

So how risky is Elegance Optical International Holdings?

By their very nature, companies that lose money are riskier than those with a long history of profitability. And over the past year, Elegance Optical International Holdings has posted a loss in earnings before interest and taxes (EBIT), if truth be told. And during the same period, it recorded a negative free cash outflow of HK$87 million and recorded a book loss of HK$76 million. Given that it only has net cash of HK$62.1 million, the company may need to raise more capital if it does not break even soon. In summary, we are a little skeptical of this one, as it looks quite risky in the absence of free cash flow. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 5 warning signs we spotted with Elegance Optical International Holdings (including 2 that don’t suit us too much).

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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