Far Eastern Department Stores (TWSE:2903) Seems To Use Debt Quite Sensibly

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.' 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 can see that Far Eastern Department Stores, Ltd. (TWSE:2903) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Far Eastern Department Stores

How Much Debt Does Far Eastern Department Stores Carry?

As you can see below, at the end of December 2023, Far Eastern Department Stores had NT$28.5b of debt, up from NT$26.2b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$22.8b, its net debt is less, at about NT$5.66b.

How Strong Is Far Eastern Department Stores' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Far Eastern Department Stores had liabilities of NT$50.4b due within 12 months and liabilities of NT$45.9b due beyond that. Offsetting this, it had NT$22.8b in cash and NT$1.99b in receivables that were due within 12 months. So its liabilities total NT$71.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$47.1b 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. After all, Far Eastern Department Stores would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Far Eastern Department Stores has a low net debt to EBITDA ratio of only 0.76. And its EBIT covers its interest expense a whopping 10.6 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Far Eastern Department Stores has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Far Eastern Department Stores will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Far Eastern Department Stores 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.

Our View

Far Eastern Department Stores's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. But truth be told its level of total liabilities had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Far Eastern Department Stores is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. To that end, you should be aware of the 1 warning sign we've spotted with Far Eastern Department Stores .

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.