Is Fortune Electric (TWSE:1519) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Fortune Electric Co., Ltd. (TWSE:1519) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Fortune Electric

What Is Fortune Electric's Debt?

You can click the graphic below for the historical numbers, but it shows that Fortune Electric had NT$940.9m of debt in March 2024, down from NT$3.39b, one year before. However, it does have NT$3.50b in cash offsetting this, leading to net cash of NT$2.56b.

How Healthy Is Fortune Electric's Balance Sheet?

We can see from the most recent balance sheet that Fortune Electric had liabilities of NT$11.0b falling due within a year, and liabilities of NT$949.0m due beyond that. Offsetting this, it had NT$3.50b in cash and NT$3.71b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$4.77b.

Of course, Fortune Electric has a market capitalization of NT$193.7b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Fortune Electric also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Fortune Electric grew its EBIT by 372% over twelve months. 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 it is future earnings, more than anything, that will determine Fortune Electric's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Fortune Electric 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, Fortune Electric 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.

Summing Up

We could understand if investors are concerned about Fortune Electric's liabilities, but we can be reassured by the fact it has has net cash of NT$2.56b. And it impressed us with free cash flow of NT$5.5b, being 124% of its EBIT. So we don't think Fortune Electric's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Fortune Electric .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.