Favite (TPE:3535) Is Carrying A Fair Bit Of Debt

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 can see that Favite, Inc. (TPE:3535) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Favite

What Is Favite's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Favite had debt of NT$860.3m, up from NT$678.6m in one year. However, because it has a cash reserve of NT$553.4m, its net debt is less, at about NT$306.9m.

How Strong Is Favite's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Favite had liabilities of NT$980.9m due within 12 months and liabilities of NT$358.2m due beyond that. Offsetting these obligations, it had cash of NT$553.4m as well as receivables valued at NT$877.2m due within 12 months. So it actually has NT$91.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Favite could probably pay off its debt with ease, as its balance sheet is far from stretched. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Favite 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.

Over 12 months, Favite made a loss at the EBIT level, and saw its revenue drop to NT$948m, which is a fall of 52%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Favite's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost NT$24m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But a profit would do more to inspire us to research the business more closely. This one is a bit too risky for our liking. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Favite (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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