Formosa Plastics (TWSE:1301) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Formosa Plastics Corporation (TWSE:1301) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Formosa Plastics

How Much Debt Does Formosa Plastics Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Formosa Plastics had debt of NT$153.5b, up from NT$117.4b in one year. However, it does have NT$76.7b in cash offsetting this, leading to net debt of about NT$76.8b.

How Healthy Is Formosa Plastics' Balance Sheet?

We can see from the most recent balance sheet that Formosa Plastics had liabilities of NT$119.7b falling due within a year, and liabilities of NT$87.0b due beyond that. Offsetting this, it had NT$76.7b in cash and NT$35.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$94.3b.

Formosa Plastics has a market capitalization of NT$244.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Formosa Plastics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Formosa Plastics had a loss before interest and tax, and actually shrunk its revenue by 2.5%, to NT$197b. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Formosa Plastics produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$4.5b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled NT$11b in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Formosa Plastics you should be aware of, and 1 of them is potentially serious.

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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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.