Large-cap companies such as CGN Power Co Ltd (SEHK:1816), with a market-capitalization of HK$93.62B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in 1816 is its financial health. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. Check out our latest analysis for CGN Power
Can 1816 service its debt comfortably?
Debt-to-equity ratio standards differ between industries, as some some are more capital-intensive than others, meaning they need more capital to carry out core operations. As a rule of thumb, a financially healthy large-cap should have a ratio less than 40%. 1816’s debt-to-equity ratio exceeds 100%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. While debt-to-equity ratio has several factors at play, an easier way to check whether 1816’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. In 1816’s case, its interest is not sufficiently covered by its profits as the ratio is 2.84x. Lenders may be more reluctant to lend out more funding as 1816’s low interest coverage already puts the company at higher risk of default.
How does 1816’s operating cash flow stack up against its debt?
A basic way to evaluate 1816’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses 1816’s debt repayment capacity, which is not a big concern for a large company. In the case of 1816, operating cash flow turned out to be 0.1x its debt level over the past twelve months. This means what 1816 can generate on an annual basis only covers less than a tenth of what it actually owes its debtors in the near term, which raises a red flag.
Next Steps:
Are you a shareholder? 1816’s high debt levels are not met with high cash flow coverage. This means investors should ask themselves if they think 1816 can improve in terms of debt management and operational efficiency. Given that 1816’s financial position may be different in the future, I suggest assessing market expectations for 1816’s future growth on our free analysis platform.