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.' 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 can see that Solareast Holdings Co., Ltd. (SHSE:603366) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Solareast Holdings
How Much Debt Does Solareast Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Solareast Holdings had CN¥350.7m of debt, an increase on CN¥40.4m, over one year. However, it does have CN¥638.1m in cash offsetting this, leading to net cash of CN¥287.3m.
A Look At Solareast Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Solareast Holdings had liabilities of CN¥2.91b due within 12 months and liabilities of CN¥144.2m due beyond that. On the other hand, it had cash of CN¥638.1m and CN¥670.0m worth of receivables due within a year. So its liabilities total CN¥1.74b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Solareast Holdings is worth CN¥4.28b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Solareast Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Solareast Holdings made a loss at the EBIT level, last year, it was also good to see that it generated CN¥142m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Solareast Holdings 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 company can only pay off debt with cold hard cash, not accounting profits. Solareast Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Solareast Holdings 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
Although Solareast Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥287.3m. And it impressed us with free cash flow of CN¥180m, being 127% of its EBIT. So we don't have any problem with Solareast Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Solareast Holdings that you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.