These 4 Measures Indicate That Far Eastern Department Stores (TWSE:2903) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Far Eastern Department Stores, Ltd. (TWSE:2903) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Far Eastern Department Stores

How Much Debt Does Far Eastern Department Stores Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Far Eastern Department Stores had NT$28.7b of debt, an increase on NT$25.6b, over one year. However, because it has a cash reserve of NT$16.3b, its net debt is less, at about NT$12.4b.

A Look At Far Eastern Department Stores' Liabilities

We can see from the most recent balance sheet that Far Eastern Department Stores had liabilities of NT$41.0b falling due within a year, and liabilities of NT$59.3b due beyond that. On the other hand, it had cash of NT$16.3b and NT$1.49b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$82.5b.

This deficit casts a shadow over the NT$32.6b company, like a colossus towering over mere mortals. 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Far Eastern Department Stores has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.5 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Far Eastern Department Stores's EBIT fell a jaw-dropping 32% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Far Eastern Department Stores'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Far Eastern Department Stores actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Far Eastern Department Stores's EBIT growth rate 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 at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Far Eastern Department Stores's balance sheet is really quite a risk to the business. 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. When analysing debt levels, the balance sheet is the obvious place to start. 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 .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.