These 4 Measures Indicate That Sterling and Wilson Renewable Energy (NSE:SWSOLAR) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sterling and Wilson Renewable Energy Limited (NSE:SWSOLAR) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Sterling and Wilson Renewable Energy

How Much Debt Does Sterling and Wilson Renewable Energy Carry?

The image below, which you can click on for greater detail, shows that Sterling and Wilson Renewable Energy had debt of ₹8.73b at the end of September 2024, a reduction from ₹21.8b over a year. However, it also had ₹5.58b in cash, and so its net debt is ₹3.15b.

How Strong Is Sterling and Wilson Renewable Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sterling and Wilson Renewable Energy had liabilities of ₹33.8b due within 12 months and liabilities of ₹5.51b due beyond that. Offsetting this, it had ₹5.58b in cash and ₹9.26b in receivables that were due within 12 months. So its liabilities total ₹24.5b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sterling and Wilson Renewable Energy has a market capitalization of ₹120.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.33 times and a disturbingly high net debt to EBITDA ratio of 6.7 hit our confidence in Sterling and Wilson Renewable Energy like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Sterling and Wilson Renewable Energy achieved a positive EBIT of ₹395m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sterling and Wilson Renewable Energy'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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Sterling and Wilson Renewable Energy actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Sterling and Wilson Renewable Energy's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Sterling and Wilson Renewable Energy's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sterling and Wilson Renewable Energy 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.