Formosa Laboratories (TPE:4746) Is Making Moderate Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Formosa Laboratories, Inc. (TPE:4746) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Laboratories

What Is Formosa Laboratories's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Formosa Laboratories had debt of NT$4.13b, up from NT$3.74b in one year. However, it also had NT$950.1m in cash, and so its net debt is NT$3.18b.

How Strong Is Formosa Laboratories' Balance Sheet?

We can see from the most recent balance sheet that Formosa Laboratories had liabilities of NT$3.48b falling due within a year, and liabilities of NT$1.56b due beyond that. Offsetting this, it had NT$950.1m in cash and NT$704.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.38b.

This is a mountain of leverage relative to its market capitalization of NT$4.99b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Formosa Laboratories'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.

In the last year Formosa Laboratories wasn't profitable at an EBIT level, but managed to grow its revenue by 9.2%, to NT$3.0b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Formosa Laboratories produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$35m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NT$807m of cash over the last year. So suffice it to say we consider the stock very risky. 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. Take risks, for example - Formosa Laboratories has 3 warning signs (and 2 which are potentially serious) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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