China Flavors and Fragrances Company Limited (SEHK:3318) is a small-cap stock with a market capitalization of HK$2.05B. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into 3318 here.

How does 3318’s operating cash flow stack up against its debt?

3318 has sustained its debt level by about CN¥1.18B over the last 12 months comprising of short- and long-term debt. At this current level of debt, 3318’s cash and short-term investments stands at CN¥175.56M , ready to deploy into the business. Moreover, 3318 has produced cash from operations of CN¥66.12M over the same time period, leading to an operating cash to total debt ratio of 5.59%, signalling that 3318’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 3318’s case, it is able to generate 0.056x cash from its debt capital.

Can 3318 meet its short-term obligations with the cash in hand?

Looking at 3318’s most recent CN¥936.79M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.06x. Generally, for Chemicals companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Is 3318’s debt level acceptable?

With debt reaching 47.32% of equity, 3318 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if 3318’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 3318, the ratio of 2.96x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

3318’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, the company exhibits proper management of current assets and upcoming liabilities. Keep in mind I haven’t considered other factors such as how 3318 has been performing in the past. I recommend you continue to research China Flavors and Fragrances to get a better picture of the stock by looking at:

1. Historical Performance: What has 3318’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

2. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.