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.' 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 can see that Solarvest Holdings Berhad (KLSE:SLVEST) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Solarvest Holdings Berhad's Debt?
The image below, which you can click on for greater detail, shows that Solarvest Holdings Berhad had debt of RM10.9m at the end of March 2021, a reduction from RM15.9m over a year. However, it does have RM76.8m in cash offsetting this, leading to net cash of RM65.9m.
A Look At Solarvest Holdings Berhad's Liabilities
The latest balance sheet data shows that Solarvest Holdings Berhad had liabilities of RM77.6m due within a year, and liabilities of RM16.0m falling due after that. Offsetting these obligations, it had cash of RM76.8m as well as receivables valued at RM99.0m due within 12 months. So it actually has RM82.2m more liquid assets than total liabilities.
This surplus suggests that Solarvest Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Solarvest Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Solarvest Holdings Berhad grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Solarvest Holdings Berhad'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Solarvest Holdings Berhad 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. Looking at the most recent three years, Solarvest Holdings Berhad recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case Solarvest Holdings Berhad has RM65.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 29% over the last year. So is Solarvest Holdings Berhad'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Solarvest Holdings Berhad has 3 warning signs (and 1 which is significant) we think 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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