These 4 Measures Indicate That Formosan Rubber Group (TPE:2107) Is Using Debt Safely

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.' 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. We note that Formosan Rubber Group Inc. (TPE:2107) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Formosan Rubber Group

What Is Formosan Rubber Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Formosan Rubber Group had NT$489.9m of debt in September 2020, down from NT$1.44b, one year before. But on the other hand it also has NT$3.65b in cash, leading to a NT$3.16b net cash position.

How Healthy Is Formosan Rubber Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Formosan Rubber Group had liabilities of NT$827.1m due within 12 months and liabilities of NT$251.8m due beyond that. On the other hand, it had cash of NT$3.65b and NT$203.1m worth of receivables due within a year. So it actually has NT$2.78b more liquid assets than total liabilities.

This surplus liquidity suggests that Formosan Rubber Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Formosan Rubber Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Formosan Rubber Group grew its EBIT by 108% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Formosan Rubber Group's earnings that will influence how the balance sheet holds up in the future. 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. Formosan Rubber Group 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. Happily for any shareholders, Formosan Rubber Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Formosan Rubber Group has NT$3.16b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 276% of that EBIT to free cash flow, bringing in NT$1.9b. The bottom line is that we do not find Formosan Rubber Group's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Formosan Rubber Group has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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