Here's Why StarPower Semiconductor (SHSE:603290) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies StarPower Semiconductor Ltd. (SHSE:603290) makes use of debt. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for StarPower Semiconductor

How Much Debt Does StarPower Semiconductor Carry?

As you can see below, at the end of September 2024, StarPower Semiconductor had CN¥1.55b of debt, up from CN¥999.6m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.14b, its net debt is less, at about CN¥405.0m.

How Strong Is StarPower Semiconductor's Balance Sheet?

We can see from the most recent balance sheet that StarPower Semiconductor had liabilities of CN¥1.07b falling due within a year, and liabilities of CN¥1.78b due beyond that. Offsetting these obligations, it had cash of CN¥1.14b as well as receivables valued at CN¥1.24b due within 12 months. So its liabilities total CN¥461.8m more than the combination of its cash and short-term receivables.

Of course, StarPower Semiconductor has a market capitalization of CN¥22.6b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

StarPower Semiconductor has a low debt to EBITDA ratio of only 0.45. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. But the bad news is that StarPower Semiconductor has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 StarPower Semiconductor'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, StarPower Semiconductor burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We feel some trepidation about StarPower Semiconductor's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that StarPower Semiconductor's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 2 warning signs for StarPower Semiconductor (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.