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

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.' 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. We note that SMA Solar Technology AG (ETR:S92) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for SMA Solar Technology

What Is SMA Solar Technology's Debt?

As you can see below, at the end of March 2024, SMA Solar Technology had €22.9m of debt, up from €15.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds €226.4m in cash, so it actually has €203.5m net cash.

A Look At SMA Solar Technology's Liabilities

We can see from the most recent balance sheet that SMA Solar Technology had liabilities of €659.3m falling due within a year, and liabilities of €281.8m due beyond that. Offsetting this, it had €226.4m in cash and €257.8m in receivables that were due within 12 months. So it has liabilities totalling €456.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because SMA Solar Technology is worth €896.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, SMA Solar Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that SMA Solar Technology grew its EBIT by 319% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SMA Solar Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. SMA Solar 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. Considering the last two years, SMA Solar Technology actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While SMA Solar Technology does have more liabilities than liquid assets, it also has net cash of €203.5m. And we liked the look of last year's 319% year-on-year EBIT growth. So we don't have any problem with SMA Solar Technology's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for SMA Solar Technology you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com