Is Solartech International Holdings (HKG:1166) 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 Solartech International Holdings Limited (HKG:1166) 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Solartech International Holdings

What Is Solartech International Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Solartech International Holdings had HK$269.6m of debt, an increase on HK$182.9m, over one year. On the flip side, it has HK$72.0m in cash leading to net debt of about HK$197.6m.

How Strong Is Solartech International Holdings' Balance Sheet?

The latest balance sheet data shows that Solartech International Holdings had liabilities of HK$405.8m due within a year, and liabilities of HK$159.9m falling due after that. Offsetting these obligations, it had cash of HK$72.0m as well as receivables valued at HK$283.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$210.4m.

This deficit is considerable relative to its market capitalization of HK$237.5m, so it does suggest shareholders should keep an eye on Solartech International Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Solartech International Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Solartech International Holdings reported revenue of HK$433m, which is a gain of 50%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Solartech International Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$22m 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. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of HK$4.4m and a profit of HK$156m. So one might argue that there's still a chance it can get things on the right track. 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. We've identified 3 warning signs with Solartech International Holdings , and understanding them should be part of your investment process.

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.

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.

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