Is Fu Yu Property (GTSM:4907) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Fu Yu Property Co., Ltd. (GTSM:4907) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Fu Yu Property

What Is Fu Yu Property's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Fu Yu Property had NT$3.97b of debt, an increase on NT$3.21b, over one year. However, because it has a cash reserve of NT$200.4m, its net debt is less, at about NT$3.77b.

A Look At Fu Yu Property's Liabilities

The latest balance sheet data shows that Fu Yu Property had liabilities of NT$3.50b due within a year, and liabilities of NT$1.84b falling due after that. On the other hand, it had cash of NT$200.4m and NT$36.4m worth of receivables due within a year. So it has liabilities totalling NT$5.10b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the NT$3.01b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Fu Yu Property would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Fu Yu Property has a sky high EBITDA ratio of 17.3, implying high debt, but a strong interest coverage of 29.2. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Fu Yu Property is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 249% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fu Yu Property will need earnings to service that debt. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Fu Yu Property burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Fu Yu Property's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We're quite clear that we consider Fu Yu Property to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example Fu Yu Property has 3 warning signs (and 2 which don't sit too well with us) we think 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. 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.
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