Is Formosa Chemicals & Fibre (TWSE:1326) A Risky Investment?

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 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. Importantly, Formosa Chemicals & Fibre Corporation (TWSE:1326) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Formosa Chemicals & Fibre

What Is Formosa Chemicals & Fibre's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Formosa Chemicals & Fibre had debt of NT$147.3b, up from NT$139.7b in one year. However, because it has a cash reserve of NT$123.9b, its net debt is less, at about NT$23.4b.

How Healthy Is Formosa Chemicals & Fibre's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Formosa Chemicals & Fibre had liabilities of NT$101.2b due within 12 months and liabilities of NT$81.0b due beyond that. Offsetting these obligations, it had cash of NT$123.9b as well as receivables valued at NT$37.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$21.1b.

Since publicly traded Formosa Chemicals & Fibre shares are worth a very impressive total of NT$322.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 Chemicals & Fibre'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.

Over 12 months, Formosa Chemicals & Fibre made a loss at the EBIT level, and saw its revenue drop to NT$333b, which is a fall of 12%. That's not what we would hope to see.

Caveat Emptor

Not only did Formosa Chemicals & Fibre's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$3.1b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled NT$2.4b in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. Be aware that Formosa Chemicals & Fibre is showing 1 warning sign in our investment analysis , 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.