Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Olympic Circuit Technology Co., Ltd (SHSE:603920) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Olympic Circuit Technology's Debt?
As you can see below, Olympic Circuit Technology had CN¥1.13b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥4.16b in cash, leading to a CN¥3.03b net cash position.
How Healthy Is Olympic Circuit Technology's Balance Sheet?
We can see from the most recent balance sheet that Olympic Circuit Technology had liabilities of CN¥1.89b falling due within a year, and liabilities of CN¥1.05b due beyond that. Offsetting this, it had CN¥4.16b in cash and CN¥1.39b in receivables that were due within 12 months. So it can boast CN¥2.61b more liquid assets than total liabilities.
This short term liquidity is a sign that Olympic Circuit Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Olympic Circuit Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Olympic Circuit Technology grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Olympic Circuit Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Olympic Circuit Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Olympic Circuit Technology actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Olympic Circuit Technology has net cash of CN¥3.03b, as well as more liquid assets than liabilities. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in CN¥1.0b. So is Olympic Circuit Technology's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Olympic Circuit Technology .
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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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.
