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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Opple Lighting Co.,LTD (SHSE:603515) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Opple LightingLTD's Debt?
The chart below, which you can click on for greater detail, shows that Opple LightingLTD had CN¥218.7m in debt in September 2023; about the same as the year before. But on the other hand it also has CN¥5.35b in cash, leading to a CN¥5.13b net cash position.
How Healthy Is Opple LightingLTD's Balance Sheet?
The latest balance sheet data shows that Opple LightingLTD had liabilities of CN¥3.04b due within a year, and liabilities of CN¥27.1m falling due after that. On the other hand, it had cash of CN¥5.35b and CN¥742.9m worth of receivables due within a year. So it actually has CN¥3.02b more liquid assets than total liabilities.
This excess liquidity suggests that Opple LightingLTD is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Opple LightingLTD has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Opple LightingLTD has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Opple LightingLTD 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Opple LightingLTD has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Opple LightingLTD generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Opple LightingLTD has net cash of CN¥5.13b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.2b, being 86% of its EBIT. When it comes to Opple LightingLTD's debt, we sufficiently relaxed that our mind turns to the jacuzzi. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Opple LightingLTD you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.