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 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. As with many other companies World Fitness Services Ltd. (TWSE:2762) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for World Fitness Services
What Is World Fitness Services’s Debt?
As you can see below, World Fitness Services had NT$707.5m of debt at March 2024, down from NT$928.8m a year prior. However, its balance sheet shows it holds NT$1.95b in cash, so it actually has NT$1.24b net cash.
How Healthy Is World Fitness Services’ Balance Sheet?
We can see from the most recent balance sheet that World Fitness Services had liabilities of NT$5.04b falling due within a year, and liabilities of NT$9.22b due beyond that. Offsetting this, it had NT$1.95b in cash and NT$187.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$12.1b.
When you consider that this deficiency exceeds the company’s NT$9.56b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. World Fitness Services boasts net cash, so it’s fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
World Fitness Services grew its EBIT by 8.9% in the last year. That’s far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine World Fitness Services’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While World Fitness Services 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. Happily for any shareholders, World Fitness Services actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
Although World Fitness Services’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$1.24b. And it impressed us with free cash flow of NT$1.4b, being 317% of its EBIT. So although we see some areas for improvement, we’re not too worried about World Fitness Services’s balance sheet. 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. Be aware that World Fitness Services is showing 1 warning sign in our investment analysis , you should know about…
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.
