Solomon Systech (International) (HKG:2878) Could Easily Take On More 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. Importantly, Solomon Systech (International) Limited (HKG:2878) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Solomon Systech (International)

What Is Solomon Systech (International)'s Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Solomon Systech (International) had debt of US$1.66m, up from US$1.42m in one year. But it also has US$82.9m in cash to offset that, meaning it has US$81.2m net cash.

A Look At Solomon Systech (International)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Solomon Systech (International) had liabilities of US$30.0m due within 12 months and liabilities of US$521.0k due beyond that. Offsetting this, it had US$82.9m in cash and US$31.6m in receivables that were due within 12 months. So it actually has US$84.0m more liquid assets than total liabilities.

This surplus strongly suggests that Solomon Systech (International) has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Solomon Systech (International) boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Solomon Systech (International)'s saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Solomon Systech (International)'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Solomon Systech (International) 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 most recent three years, Solomon Systech (International) recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Solomon Systech (International) has net cash of US$81.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in US$37m. So is Solomon Systech (International)'s debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Solomon Systech (International) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.