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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that OFILM Group Co., Ltd. (SZSE:002456) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is OFILM Group's Debt?
The image below, which you can click on for greater detail, shows that OFILM Group had debt of CN¥6.92b at the end of September 2023, a reduction from CN¥8.42b over a year. However, it also had CN¥1.94b in cash, and so its net debt is CN¥4.98b.
How Healthy Is OFILM Group's Balance Sheet?
The latest balance sheet data shows that OFILM Group had liabilities of CN¥12.1b due within a year, and liabilities of CN¥1.75b falling due after that. Offsetting these obligations, it had cash of CN¥1.94b as well as receivables valued at CN¥5.21b due within 12 months. So it has liabilities totalling CN¥6.68b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since OFILM Group has a market capitalization of CN¥30.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine OFILM Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year OFILM Group had a loss before interest and tax, and actually shrunk its revenue by 10%, to CN¥15b. That's not what we would hope to see.
Caveat Emptor
Not only did OFILM Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥2.6b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of CN¥2.2b. So we do think this stock is quite risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how OFILM Group's profit, revenue, and operating cashflow have changed over the last few years.
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.