Fwusow Industry (TPE:1219) Has A Pretty Healthy Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Fwusow Industry Co., Ltd. (TPE:1219) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Fwusow Industry

What Is Fwusow Industry's Net Debt?

The image below, which you can click on for greater detail, shows that Fwusow Industry had debt of NT$2.91b at the end of December 2020, a reduction from NT$3.83b over a year. On the flip side, it has NT$1.09b in cash leading to net debt of about NT$1.82b.

A Look At Fwusow Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Fwusow Industry had liabilities of NT$2.01b due within 12 months and liabilities of NT$2.10b due beyond that. Offsetting this, it had NT$1.09b in cash and NT$1.42b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.59b.

This deficit isn't so bad because Fwusow Industry is worth NT$6.95b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Fwusow Industry has net debt to EBITDA of 3.2 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.9 suggests it can easily service that debt. Pleasingly, Fwusow Industry is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 844% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Fwusow Industry will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Fwusow Industry recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Fwusow Industry's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Zooming out, Fwusow Industry seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Fwusow Industry you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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