In This Article:
While small-cap stocks, such as China Flavors and Fragrances Company Limited (HKG:3318) with its market cap of HK$2.1b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. However, this commentary is still very high-level, so I suggest you dig deeper yourself into 3318 here.
Does 3318 produce enough cash relative to debt?
3318 has built up its total debt levels in the last twelve months, from CN¥1.2b to CN¥1.3b , which comprises of short- and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at CN¥282m , ready to deploy into the business. Additionally, 3318 has produced cash from operations of CN¥164m over the same time period, resulting in an operating cash to total debt ratio of 12%, signalling that 3318’s operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 3318’s case, it is able to generate 0.12x cash from its debt capital.
Can 3318 meet its short-term obligations with the cash in hand?
At the current liabilities level of CN¥1.2b liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥1.2b, leading to a 1.01x current account ratio. Usually, for Chemicals companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Is 3318’s debt level acceptable?
3318 is a relatively highly levered company with a debt-to-equity of 51%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether 3318 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 3318’s, case, the ratio of 2.35x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as 3318’s low interest coverage already puts the company at higher risk of default.
Next Steps:
3318’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. This is only a rough assessment of financial health, and I’m sure 3318 has company-specific issues impacting its capital structure decisions. I recommend you continue to research China Flavors and Fragrances to get a more holistic view of the stock by looking at: