Solar Applied Materials Technology (GTSM:1785) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Solar Applied Materials Technology Corporation (GTSM:1785) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Solar Applied Materials Technology

How Much Debt Does Solar Applied Materials Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Solar Applied Materials Technology had NT$11.0b of debt in September 2020, down from NT$12.5b, one year before. However, it does have NT$1.91b in cash offsetting this, leading to net debt of about NT$9.12b.

How Healthy Is Solar Applied Materials Technology's Balance Sheet?

The latest balance sheet data shows that Solar Applied Materials Technology had liabilities of NT$2.23b due within a year, and liabilities of NT$10.6b falling due after that. On the other hand, it had cash of NT$1.91b and NT$1.99b worth of receivables due within a year. So it has liabilities totalling NT$8.92b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Solar Applied Materials Technology has a market capitalization of NT$21.9b, 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 5.3, it's fair to say Solar Applied Materials Technology does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 5.0 times, suggesting it can responsibly service its obligations. Unfortunately, Solar Applied Materials Technology saw its EBIT slide 6.2% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Solar Applied Materials Technology'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Solar Applied Materials Technology actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both Solar Applied Materials Technology's conversion of EBIT to free cash flow and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Overall, we think it's fair to say that Solar Applied Materials Technology has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 Solar Applied Materials Technology has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

If you’re looking to trade Solar Applied Materials Technology, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.