Is Formosa Electronic Industries (GTSM:8171) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Formosa Electronic Industries Inc. (GTSM:8171) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Formosa Electronic Industries

What Is Formosa Electronic Industries's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Formosa Electronic Industries had debt of NT$274.9m, up from NT$231.7m in one year. But on the other hand it also has NT$459.5m in cash, leading to a NT$184.6m net cash position.

How Healthy Is Formosa Electronic Industries' Balance Sheet?

According to the last reported balance sheet, Formosa Electronic Industries had liabilities of NT$333.8m due within 12 months, and liabilities of NT$5.86m due beyond 12 months. Offsetting these obligations, it had cash of NT$459.5m as well as receivables valued at NT$35.6m due within 12 months. So it actually has NT$155.5m more liquid assets than total liabilities.

This surplus suggests that Formosa Electronic Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Formosa Electronic Industries boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Formosa Electronic Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Formosa Electronic Industries wasn't profitable at an EBIT level, but managed to grow its revenue by 83%, to NT$244m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Formosa Electronic Industries?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Formosa Electronic Industries had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of NT$130m and booked a NT$74m accounting loss. But at least it has NT$184.6m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Formosa Electronic Industries may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Formosa Electronic Industries 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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