Some say that volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett famously said, “Volatility is far from synonymous with risk.” It is only natural to consider a company’s balance sheet when investigating how risky it is, as debt often arises when a company collapses. We write that down Formosa International Hotels Corporation (TPE: 2707) has debt on its balance sheet. The real question, however, is whether these debts make the company risky.

What is the risk of debt?

Debt and other liabilities become risky for a company when it cannot easily meet those obligations with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction,” in which failed companies are mercilessly liquidated by their bankers. However, a more common (but still expensive) situation is that a company needs to water down shareholders at a cheap stock price in order to get the debt under control. However, the most common situation is that a company is managing its debt reasonably well – and for its own benefit. When thinking about a company’s use of debt, let’s first look at cash and debt together.

Check out our latest analysis for Formosa International Hotels

What is Formosa International Hotels Debt?

The image below, which you can click for more details, shows that Formosa International Hotels had a debt of NT $ 1.40 billion at the end of September 2020, a decrease of NT $ 1.84 billion over a year . On the other hand, it also has NT $ 1.98 billion in cash, resulting in a net cash position of NT $ 581.2 million.

TSEC: 2707 Debt to Equity History January 18, 2021

How strong is the Formosa International Hotels record?

The latest balance sheet data shows that Formosa International Hotels had NT $ 3.48 billion in debt within one year and NT $ 3.77 billion in debt after maturity. These commitments were due within 12 months of NT $ 1.98 billion in cash and NT $ 585.5 million in receivables. So liabilities total NT $ 4.68 billion more than cash and short-term receivables combined.

While this seems like a lot, it’s not that bad as Formosa International Hotels has a market cap of NT $ 16.8 billion and therefore could potentially bolster its balance sheet by raising capital if needed. However, it is clear that in any case, we should look carefully to see if it can manage its debt without dilution. Formosa International Hotels, while notable in debt, also has more cash than debt. So we are pretty confident that it can safely manage its debt.

Indeed, Formosa International Hotels’ bailout is low debt as EBIT is up 37% over the past twelve months. Falling profits (if the trend continues) could ultimately make even modest debt quite risky. Clearly, the balance sheet is the area to focus on when analyzing debt. However, the results of Formosa International Hotels will have an impact on how the balance sheet holds up in the future. So when looking at debt, it’s definitely worth looking at earnings. Click here for an interactive snapshot.

After all, a business needs free cash flow to pay off debt. Accounting profits just don’t cut it. Even though Formosa International Hotels has a net present value on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and taxes (EBIT) into free cash flow to understand how quickly this built (or undermined) ) becomes cash balance. For the past three years, Formosa International Hotels have actually generated more free cash flow than EBIT. This kind of heavy cash conversion excites us as much as we do the crowd when the beat wears off at a daft punk concert.

Sum up

While Formosa International Hotels’ balance sheet is not particularly strong given its total debt, it is clearly positive to see that the company has a net present value of NT $ 581.2 million. The cherry on top was that 143% of that EBIT was converted to free cash flow for NT $ 2.2 billion. So we have no problem with Formosa International Hotels using debt. There is no doubt that we learn the most about debt from the balance sheet. Ultimately, however, any business may have off-balance sheet risks. Note that Formosa International Hotels shows 3 warning signs in our investment analysis , you should know about …

After all that, if you’re more interested in a fast-growing company with a solid balance sheet, then this is the place to look our list of net cash growth stocks without delay.

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