These 4 Measures Indicate That Solid Automotive Berhad (KLSE:SOLID) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Solid Automotive Berhad (KLSE:SOLID) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Solid Automotive Berhad

What Is Solid Automotive Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Solid Automotive Berhad had debt of RM41.2m at the end of January 2021, a reduction from RM51.4m over a year. But it also has RM47.3m in cash to offset that, meaning it has RM6.07m net cash.

A Look At Solid Automotive Berhad's Liabilities

According to the last reported balance sheet, Solid Automotive Berhad had liabilities of RM78.5m due within 12 months, and liabilities of RM15.3m due beyond 12 months. On the other hand, it had cash of RM47.3m and RM76.7m worth of receivables due within a year. So it can boast RM30.2m more liquid assets than total liabilities.

This excess liquidity suggests that Solid Automotive Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Solid Automotive Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Solid Automotive Berhad grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Solid Automotive Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent three years, Solid Automotive Berhad recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Solid Automotive Berhad has net cash of RM6.07m, as well as more liquid assets than liabilities. And we liked the look of last year's 45% year-on-year EBIT growth. So we don't think Solid Automotive Berhad's use of debt is risky. 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. For example Solid Automotive Berhad has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.

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