Formosa Petrochemical (TWSE:6505) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Formosa Petrochemical Corporation (TWSE:6505) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Formosa Petrochemical

What Is Formosa Petrochemical's Debt?

You can click the graphic below for the historical numbers, but it shows that Formosa Petrochemical had NT$28.4b of debt in December 2023, down from NT$52.3b, one year before. But it also has NT$96.9b in cash to offset that, meaning it has NT$68.5b net cash.

How Strong Is Formosa Petrochemical's Balance Sheet?

The latest balance sheet data shows that Formosa Petrochemical had liabilities of NT$44.5b due within a year, and liabilities of NT$30.5b falling due after that. Offsetting these obligations, it had cash of NT$96.9b as well as receivables valued at NT$60.3b due within 12 months. So it can boast NT$82.2b more liquid assets than total liabilities.

This short term liquidity is a sign that Formosa Petrochemical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Formosa Petrochemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Formosa Petrochemical grew its EBIT by 189% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Formosa Petrochemical'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, a company can only pay off debt with cold hard cash, not accounting profits. Formosa Petrochemical 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. During the last three years, Formosa Petrochemical produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Formosa Petrochemical has net cash of NT$68.5b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 189% over the last year. So we don't think Formosa Petrochemical's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Formosa Petrochemical you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.