Solaria Energía y Medio Ambiente (BME:SLR) Use Of Debt Could Be Considered Risky

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. As with many other companies Solaria Energía y Medio Ambiente, S.A. (BME:SLR) makes use of debt. But the more important question is: how much risk is that debt creating?

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Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Solaria Energía y Medio Ambiente's Debt?

The image below, which you can click on for greater detail, shows that at March 2025 Solaria Energía y Medio Ambiente had debt of €1.03b, up from €966.1m in one year. However, it does have €41.1m in cash offsetting this, leading to net debt of about €985.8m.

How Healthy Is Solaria Energía y Medio Ambiente's Balance Sheet?

We can see from the most recent balance sheet that Solaria Energía y Medio Ambiente had liabilities of €294.3m falling due within a year, and liabilities of €1.09b due beyond that. Offsetting this, it had €41.1m in cash and €58.2m in receivables that were due within 12 months. So it has liabilities totalling €1.28b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €1.30b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

Check out our latest analysis for Solaria Energía y Medio Ambiente

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Solaria Energía y Medio Ambiente's debt is 4.9 times its EBITDA, and its EBIT cover its interest expense 4.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even more troubling is the fact that Solaria Energía y Medio Ambiente actually let its EBIT decrease by 5.7% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. 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 Solaria Energía y Medio Ambiente'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Solaria Energía y Medio Ambiente saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Solaria Energía y Medio Ambiente's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. And even its EBIT growth rate fails to inspire much confidence. Overall, it seems to us that Solaria Energía y Medio Ambiente's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Solaria Energía y Medio Ambiente (of which 2 are concerning!) you should know about.

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.