Here's Why REC Silicon (OB:RECSI) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 REC Silicon ASA (OB:RECSI) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for REC Silicon

How Much Debt Does REC Silicon Carry?

The chart below, which you can click on for greater detail, shows that REC Silicon had US$139.7m in debt in June 2021; about the same as the year before. However, it also had US$123.6m in cash, and so its net debt is US$16.1m.

How Strong Is REC Silicon's Balance Sheet?

We can see from the most recent balance sheet that REC Silicon had liabilities of US$55.3m falling due within a year, and liabilities of US$220.2m due beyond that. Offsetting these obligations, it had cash of US$123.6m as well as receivables valued at US$20.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$131.2m.

Given REC Silicon has a market capitalization of US$731.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine REC Silicon'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.

Over 12 months, REC Silicon reported revenue of US$130m, which is a gain of 5.1%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, REC Silicon had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$23m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$10m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - REC Silicon has 1 warning sign we think you should be aware of.

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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