Favite (TPE:3535) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Favite, Inc. (TPE:3535) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Favite

What Is Favite's Debt?

The image below, which you can click on for greater detail, shows that Favite had debt of NT$691.7m at the end of December 2020, a reduction from NT$725.3m over a year. However, its balance sheet shows it holds NT$699.4m in cash, so it actually has NT$7.65m net cash.

How Strong Is Favite's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Favite had liabilities of NT$1.16b due within 12 months and liabilities of NT$347.4m due beyond that. Offsetting these obligations, it had cash of NT$699.4m as well as receivables valued at NT$793.2m due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Favite's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NT$1.52b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Favite also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Favite's EBIT was down 99% last year. 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 Favite's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Favite 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, Favite actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Favite has NT$7.65m in net cash. And it impressed us with free cash flow of NT$264m, being 201% of its EBIT. So we are not troubled with Favite's debt use. 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. We've identified 3 warning signs with Favite (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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