Optima Automobile Group Holdings (HKG:8418) has debt but no profit; Should you be worried?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Optima Automobile Group Holdings Limited (HKG:8418) uses debt in his business. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Our analysis indicates that 8418 is potentially overvalued!

How much debt does Optima Automobile Group Holdings have?

You can click on the graph below for historical figures, but it shows that in June 2022, Optima Automobile Group Holdings had a debt of S$6.89 million, an increase of S$1.00 million , over one year. But he also has S$10.5 million in cash to offset that, meaning he has a net cash of S$3.66 million.

A look at the liabilities of Optima Automobile Group Holdings

The latest balance sheet data shows that Optima Automobile Group Holdings had liabilities of S$14.7 million due within one year, and liabilities of S$7.14 million falling due thereafter. As compensation for these obligations, it had cash of S$10.5 million as well as receivables valued at S$2.16 million maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of S$9.18 million.

Given that publicly traded shares of Optima Automobile Group Holdings are worth a total of S$121.1 million, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. Despite its notable liabilities, Optima Automobile Group Holdings has net cash, so it’s fair to say that it doesn’t have heavy debt! When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Optima Automobile Group Holdings will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

On a 12-month basis, Optima Automobile Group Holdings reported revenue of S$84 million, a 173% gain, although it reported no earnings before interest and tax. Its fairly obvious shareholders therefore hope for more growth!

So how risky is Optima Automobile Group Holdings?

While Optima Automobile Group Holdings lost money in earnings before interest and tax (EBIT), it actually generated positive free cash flow of S$435,000. So taking that at face value and given the net cash position, we don’t think the stock is too risky in the near term. A silver lining is that Optima Automobile Group Holdings is growing revenue quickly, making it easy to sell a growth story and raise capital if needed. But that doesn’t change our view that the stock is risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Optima Automobile Group Holdings (1 is potentially serious!) which you should be aware of before investing here.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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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.