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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Fu Burg Industrial Co., Ltd. (GTSM:8929) does use debt in its business. But the real question is whether this debt is making the company risky.
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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Fu Burg Industrial's Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Fu Burg Industrial had debt of NT$203.8m, up from NT$139.9m in one year. However, it does have NT$639.8m in cash offsetting this, leading to net cash of NT$436.0m.
How Strong Is Fu Burg Industrial's Balance Sheet?
The latest balance sheet data shows that Fu Burg Industrial had liabilities of NT$365.9m due within a year, and liabilities of NT$117.8m falling due after that. Offsetting these obligations, it had cash of NT$639.8m as well as receivables valued at NT$188.4m due within 12 months. So it actually has NT$344.6m more liquid assets than total liabilities.
This excess liquidity is a great indication that Fu Burg Industrial's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Fu Burg Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Fu Burg Industrial grew its EBIT by 5,467% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fu Burg Industrial 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Fu Burg Industrial 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. Over the last three years, Fu Burg Industrial recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Fu Burg Industrial has NT$436.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in NT$184m. When it comes to Fu Burg Industrial's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. We've identified 5 warning signs with Fu Burg Industrial (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
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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