Is SMA Solar Technology (ETR:S92) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, SMA Solar Technology AG (ETR:S92) does carry debt. But should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SMA Solar Technology

What Is SMA Solar Technology's Debt?

The image below, which you can click on for greater detail, shows that at December 2022 SMA Solar Technology had debt of €23.7m, up from €8.36m in one year. However, its balance sheet shows it holds €206.6m in cash, so it actually has €182.9m net cash.

How Healthy Is SMA Solar Technology's Balance Sheet?

According to the last reported balance sheet, SMA Solar Technology had liabilities of €382.2m due within 12 months, and liabilities of €264.3m due beyond 12 months. Offsetting these obligations, it had cash of €206.6m as well as receivables valued at €183.2m due within 12 months. So its liabilities total €256.7m more than the combination of its cash and short-term receivables.

Since publicly traded SMA Solar Technology shares are worth a total of €3.43b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, SMA Solar Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that SMA Solar Technology improved its EBIT from a last year's loss to a positive €32m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine SMA Solar 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While SMA Solar Technology 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. Over the last year, SMA Solar Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about SMA Solar Technology's liabilities, but we can be reassured by the fact it has has net cash of €182.9m. So we don't have any problem with SMA Solar Technology's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for SMA Solar Technology you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.