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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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that SolarEdge Technologies, Inc. (NASDAQ:SEDG) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
How Much Debt Does SolarEdge Technologies Carry?
You can click the graphic below for the historical numbers, but it shows that SolarEdge Technologies had US$5.14m of debt in March 2020, down from US$24.3m, one year before. However, it does have US$427.3m in cash offsetting this, leading to net cash of US$422.2m.
A Look At SolarEdge Technologies's Liabilities
We can see from the most recent balance sheet that SolarEdge Technologies had liabilities of US$389.7m falling due within a year, and liabilities of US$257.7m due beyond that. On the other hand, it had cash of US$427.3m and US$235.7m worth of receivables due within a year. So it can boast US$15.6m more liquid assets than total liabilities.
This state of affairs indicates that SolarEdge Technologies's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$7.68b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, SolarEdge Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, SolarEdge Technologies grew its EBIT by 102% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SolarEdge Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SolarEdge Technologies 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. Happily for any shareholders, SolarEdge Technologies actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that SolarEdge Technologies has net cash of US$422.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in US$221m. So we don't think SolarEdge Technologies's use of debt is risky. 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. Take risks, for example - SolarEdge Technologies has 3 warning signs we think you should be aware of.
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.
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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