Fortune Information Systems (TPE:2468) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Fortune Information Systems Corp (TPE:2468) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Fortune Information Systems

What Is Fortune Information Systems's Net Debt?

The image below, which you can click on for greater detail, shows that Fortune Information Systems had debt of NT$80.0m at the end of September 2020, a reduction from NT$215.0m over a year. However, its balance sheet shows it holds NT$176.4m in cash, so it actually has NT$96.4m net cash.

How Strong Is Fortune Information Systems' Balance Sheet?

The latest balance sheet data shows that Fortune Information Systems had liabilities of NT$527.6m due within a year, and liabilities of NT$7.85m falling due after that. Offsetting this, it had NT$176.4m in cash and NT$745.4m in receivables that were due within 12 months. So it can boast NT$386.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Fortune Information Systems' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Fortune Information Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Fortune Information Systems grew its EBIT by 72% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Fortune Information Systems 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fortune Information Systems has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Fortune Information Systems saw substantial negative free cash flow, in total. 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Fortune Information Systems has net cash of NT$96.4m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 72% over the last year. So is Fortune Information Systems's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Fortune Information Systems (1 makes us a bit uncomfortable) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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