Solid Automotive Berhad (KLSE:SOLID) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Solid Automotive Berhad (KLSE:SOLID) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Solid Automotive Berhad

How Much Debt Does Solid Automotive Berhad Carry?

The image below, which you can click on for greater detail, shows that Solid Automotive Berhad had debt of RM24.9m at the end of July 2021, a reduction from RM43.6m over a year. However, it does have RM46.2m in cash offsetting this, leading to net cash of RM21.2m.

How Strong Is Solid Automotive Berhad's Balance Sheet?

The latest balance sheet data shows that Solid Automotive Berhad had liabilities of RM57.4m due within a year, and liabilities of RM10.1m falling due after that. Offsetting this, it had RM46.2m in cash and RM60.1m in receivables that were due within 12 months. So it actually has RM38.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Solid Automotive Berhad's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Solid Automotive Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Solid Automotive Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM17m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Solid Automotive Berhad'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 company can only pay off debt with cold hard cash, not accounting profits. While Solid Automotive 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. Happily for any shareholders, Solid Automotive Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Solid Automotive Berhad has net cash of RM21.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM18m, being 105% of its EBIT. So we don't think Solid Automotive Berhad's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Solid Automotive Berhad (of which 1 is concerning!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.