We Think Jia Wei Lifestyle (TPE:3557) Can Manage Its Debt With Ease

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 can see that Jia Wei Lifestyle, Inc. (TPE:3557) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Jia Wei Lifestyle

How Much Debt Does Jia Wei Lifestyle Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Jia Wei Lifestyle had debt of NT$1.09b, up from NT$774.0m in one year. However, it also had NT$224.0m in cash, and so its net debt is NT$870.6m.

How Healthy Is Jia Wei Lifestyle's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jia Wei Lifestyle had liabilities of NT$2.06b due within 12 months and liabilities of NT$360.4m due beyond that. Offsetting this, it had NT$224.0m in cash and NT$841.4m in receivables that were due within 12 months. So it has liabilities totalling NT$1.36b more than its cash and near-term receivables, combined.

Since publicly traded Jia Wei Lifestyle shares are worth a total of NT$7.41b, it seems unlikely that this level of liabilities would be a major 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jia Wei Lifestyle's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 29.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Jia Wei Lifestyle grew its EBIT by 10,622% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Jia Wei Lifestyle's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Jia Wei Lifestyle generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Jia Wei Lifestyle's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Jia Wei Lifestyle is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Jia Wei Lifestyle .

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. 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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