Is Formosa International Hotels (TWSE:2707) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Formosa International Hotels Corporation (TWSE:2707) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Formosa International Hotels

What Is Formosa International Hotels's Debt?

As you can see below, Formosa International Hotels had NT$86.7m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have NT$3.66b in cash offsetting this, leading to net cash of NT$3.58b.

A Look At Formosa International Hotels' Liabilities

We can see from the most recent balance sheet that Formosa International Hotels had liabilities of NT$2.84b falling due within a year, and liabilities of NT$2.84b due beyond that. On the other hand, it had cash of NT$3.66b and NT$637.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.38b.

Given Formosa International Hotels has a market capitalization of NT$30.1b, 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. While it does have liabilities worth noting, Formosa International Hotels also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Formosa International Hotels has boosted its EBIT by 51%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Formosa International Hotels can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Formosa International Hotels has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Formosa International Hotels generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Formosa International Hotels has NT$3.58b in net cash. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in NT$1.6b. So we don't think Formosa International Hotels's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Formosa International Hotels you should be aware of.

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.