These 4 Measures Indicate That SolTech Energy Sweden (STO:SOLT) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies SolTech Energy Sweden AB (publ) (STO:SOLT) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for SolTech Energy Sweden

What Is SolTech Energy Sweden's Net Debt?

As you can see below, SolTech Energy Sweden had kr870.6m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had kr222.5m in cash, and so its net debt is kr648.1m.

How Strong Is SolTech Energy Sweden's Balance Sheet?

According to the last reported balance sheet, SolTech Energy Sweden had liabilities of kr164.1m due within 12 months, and liabilities of kr1.04b due beyond 12 months. On the other hand, it had cash of kr222.5m and kr135.9m worth of receivables due within a year. So its liabilities total kr848.1m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since SolTech Energy Sweden has a market capitalization of kr1.75b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.41 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in SolTech Energy Sweden like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Looking on the bright side, SolTech Energy Sweden boosted its EBIT by a silky 74% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SolTech Energy Sweden 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.

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 that EBIT is backed by free cash flow. Over the last three years, SolTech Energy Sweden saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, SolTech Energy Sweden's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that SolTech Energy Sweden's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Be aware that SolTech Energy Sweden is showing 5 warning signs in our investment analysis , and 2 of those are concerning...

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. 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.
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