Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Jia Wei Lifestyle, Inc. (TPE:3557) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Jia Wei Lifestyle
What Is Jia Wei Lifestyle’s Net Debt?
As you can see below, at the end of December 2020, Jia Wei Lifestyle had NT$1.79b of debt, up from NT$1.49b a year ago. Click the image for more detail. However, it also had NT$369.6m in cash, and so its net debt is NT$1.42b.
A Look At Jia Wei Lifestyle’s Liabilities
Zooming in on the latest balance sheet data, we can see that Jia Wei Lifestyle had liabilities of NT$2.12b due within 12 months and liabilities of NT$780.9m due beyond that. On the other hand, it had cash of NT$369.6m and NT$905.9m worth of receivables due within a year. So its liabilities total NT$1.63b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Jia Wei Lifestyle has a market capitalization of NT$6.64b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
We’d say that Jia Wei Lifestyle’s moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its strong interest cover of 34.7 times, makes us even more comfortable. Even more impressive was the fact that Jia Wei Lifestyle grew its EBIT by 423% over twelve months. That boost will make it even easier to pay down debt going forward. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Jia Wei Lifestyle 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent two years, Jia Wei Lifestyle recorded free cash flow of 34% of its EBIT, which is weaker than we’d expect. That’s not great, when it comes to paying down debt.
Jia Wei Lifestyle’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Jia Wei Lifestyle takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For instance, we’ve identified 2 warning signs for Jia Wei Lifestyle that you should be aware of.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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