Is Fulin Plastic Industry (Cayman) Holding (TPE:1341) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Fulin Plastic Industry (Cayman) Holding Co., Ltd. (TPE:1341) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Fulin Plastic Industry (Cayman) Holding

What Is Fulin Plastic Industry (Cayman) Holding's Net Debt?

As you can see below, Fulin Plastic Industry (Cayman) Holding had NT$646.5m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$241.9m in cash leading to net debt of about NT$404.6m.

How Strong Is Fulin Plastic Industry (Cayman) Holding's Balance Sheet?

The latest balance sheet data shows that Fulin Plastic Industry (Cayman) Holding had liabilities of NT$775.0m due within a year, and liabilities of NT$163.5m falling due after that. Offsetting this, it had NT$241.9m in cash and NT$356.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$340.5m.

Given Fulin Plastic Industry (Cayman) Holding has a market capitalization of NT$2.89b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fulin Plastic Industry (Cayman) Holding has a low net debt to EBITDA ratio of only 0.88. And its EBIT covers its interest expense a whopping 28.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Fulin Plastic Industry (Cayman) Holding has increased its EBIT by 3.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fulin Plastic Industry (Cayman) Holding 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Fulin Plastic Industry (Cayman) Holding reported free cash flow worth 5.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On our analysis Fulin Plastic Industry (Cayman) Holding's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. When we consider all the elements mentioned above, it seems to us that Fulin Plastic Industry (Cayman) Holding is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Fulin Plastic Industry (Cayman) Holding , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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